Artemis UK Smaller Companies Fund update

Source for all information: Artemis as at 30 June 2024, unless otherwise stated. The fund’s objective is to grow capital over a five-year period.

Fund objective

The fund’s objective is to grow capital over a five-year period. 

Performance 

The Artemis UK Smaller Companies Fund returned 11.1% in the second quarter of 2024, compared with gains of 5.2% from its first benchmark, the Deutsche Numis UK Smaller Companies (-InvTrust) index¹, and 7.5% from its second benchmark, the IA UK Smaller Companies sector² average. 

For five-year annualised performance, see below. Please remember that past performance is not a guide to the future.

After years of negativity towards UK smaller companies, chinks of light have started to appear. Real incomes (wages after inflation is taken into account) are rising³, consumer confidence is on the up⁴ and the flow of money into funds is finally showing signs of improvement⁵.

Even if these don’t translate into a meaningful increase in share prices, takeover activity and share buybacks⁶ should continue to support returns. The fund has now received 30 recommended offers for its portfolio holdings since the start of 2019, at an average premium of 50% to the share price. This illustrates the value in both the fund and UK smaller companies and represents a third-party validation of the traits we look for – notably market-leading niches, strong cashflows (the money left after all liabilities have been paid) and low levels of debt.

Turning to buybacks, 13 of the fund’s holdings reduced their share count by more than 0.5% in the first half of the year⁷, with the biggest reduction at property manager Mears (13% over the past 12 months). But please remember that reference to specific shares or companies should not be taken as advice or a recommendation to invest in them. Buybacks are not traditionally associated with smaller companies, but are indicative of management teams’ views of:

• A more favourable outlook
• Low levels of debt
• Attractive valuations

Positives

Among the biggest contributors to performance during the quarter were Future, Britvic and Alpha Financial Markets. We also benefited from avoiding pharmaceutical Indivior.

Publisher Future’s valuation was so low in May that a trading statement that was in line with expectations was all it took for its shares to rise 60% in that month. It announced £45m of share buybacks.

Alpha Financial Markets (specialist consultant to asset managers and insurance companies) and Britvic (soft drinks manufacturer and UK bottler for Pepsi) both received takeover approaches (offers to buy the companies) in June. The former accepted a cash offer at a 51% premium to the pre-offer share price.

After rejecting two approaches from Carlsberg at 1200p and 1250p, Britvic finally accepted one at 1,290p. This represented a premium of about 36% to its pre-offer share price.

Negatives

Performance was held back by our travel & leisure positions – specifically SSP, On the Beach and Jet2.

SSP, which operates food & beverage outlets in travel locations such as airports and stations, has been weak this year. An increase in investment has depressed near-term cashflow, but our analysis suggests the money it has deployed in this way will eventually deliver attractive returns and help the company make the most of the significant growth opportunity ahead of it (particularly in North America).

In December, online travel agent On the Beach said that "summer 2024 was trading significantly ahead of 2023" at that early stage of the booking season. The shares jumped by 58%. They have given up some of these gains this year, even though the company has predicted “another record summer” in its most recent report.

It was a similar story for package holiday operator Jet2, which claimed to be "well set for a successful summer" even though it warned of more competitive pricing in the industry. Its shares have given up most of the gains delivered in the first quarter.

Despite the poor performance of travel & leisure shares, we remain positive on the sector: forecasts on UK GDP (gross domestic product) growth consistently underestimate the strength of the domestic economy, while the consumer is in a much better position than headlines suggest.

Activity

Our two biggest purchases were wound-care specialist AOTI (Advanced Oxygen Therapy, Inc) and Warpaint, which sells affordable cosmetics under the W7 and Technic brands.

AOTI is the market leader in using topical oxygen therapy (TWO2) to heal diabetic foot ulcers, principally in the US. Strong trial data indicates this treatment is more effective and results in lower levels of recurrence than traditional methods, leading to better patient outcomes. In addition, fewer hospitalisations and amputations help to reduce overall costs. The combination of high growth (about 40% a year), a large opportunity (the nationwide potential is yet to be factored into forecasts) and profit margins of more than 80% should soon translate into strong cashflows. Incidentally, AOTI is only the second IPO (initial public offering) that we have participated in since 2018.

Turning to Warpaint, we can think of few companies where growth is not just strong (sales were up 40% last year), but so broad based – by geography (up 18% in the UK, 37% in the US, 61% in Europe and 57% in the rest of the world) and brand (up 21% for Technic and 64% for W7).

Most of our biggest sales in the quarter could be attributed to profit taking. We trimmed positions in Future, Hollywood Bowl, engineer Keller and publisher Wilmington.

The change in government

The Labour manifesto is light on big promises but, in spite of its title 'Change', actually makes a welcome commitment to 'stability' (a word that appears 14 times in the manifesto). Economic and political stability, together with an aspiration to strengthen relationships with Europe (albeit ruling out either a return to the European Union or rejoining the single market), could be an important step in re-writing the current negative narrative surrounding the UK. After years of outflows, a small change in sentiment could have a magnified impact on the UK smaller companies market.