Artemis UK Smaller Companies Fund update

Source for all information: Artemis as at 31 December 2024, unless otherwise stated. 

Fund objective

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

Performance 

The Artemis UK Smaller Companies Fund lost 3.2% in the quarter, compared with losses of 1.2% from its first benchmark, the Deutsche Numis UK Smaller Companies (-InvTrust) index¹, and 2.1% 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.

The quarter was dominated by the Budget, which we felt was largely sensible, resisting a political pull to the extremes. The increase in national insurance contributions and the reduction in the threshold at which these begin accounted for the majority of tax rises. Businesses with a large proportion of relatively low-paid employees will also have to contend with an increase in the minimum wage. These changes will have the biggest impact on employee-intensive, low profit-margin companies without pricing power (the ability to pass costs onto customers).

Yet we are wary of the sensational headlines seen since the end of October. Consumer, business and investment sentiment can change quickly and we continue to believe that the economic picture is better than commonly reported.

Negatives

Three Court of Appeal decisions relating to car loans went against FirstRand Bank and Close Brothers. Although we don’t own these companies (and the cases will now be appealed at the Supreme Court), the rulings had implications for our holdings in specialist lender Vanquis and Secure Trust Bank, which both face a potentially large compensation bill.

The latter of these was the biggest contributor to the fund’s underperformance during the quarter after it issued a warning that profits would be lower than expected because of a slower recovery in its car-loan division, after a regulatory review led to a temporary pause in debt collections and a higher default rate among its customers. However, the shares are now trading at a significant discount to the value of the company’s assets and we believe they offer substantial potential upside in compensation for the undoubtedly high risk.

Serco, a provider of outsourcing services, lost a large contract with the Australian government, while the increases to national insurance contributions and the minimum wage announced in the Budget prompted it to cut profit expectations in 2025. We added to our position.

Videndum, which provides hardware and software to the film industry, warned that profits would be lower as the new management team noted a slower-than-expected market recovery from the Hollywood writers' strike.

Positives

Package holiday operator On The Beach reported strong results for the 2024 financial year, highlighting: confidence that “summer 2025 will be significantly ahead of summer 2024”; a new share buyback programme³; and expectations that profits will grow significantly over the next five years. While On The Beach’s share price does not look expensive, we took some profits to stop the company becoming an oversized position in the fund.

Beeks, a provider of cloud computing services to the financial services industry, released solid results that were superseded by comments about “several major international [financial] exchanges entering the final stages of contracting”. These contracts, combined with those it has already won with other financial exchanges, could transform its profits over the next few years.

Eckoh, a provider of secure payments systems in customer service centres, received a takeover bid. While the shares rose following the news, we felt the bid underestimated the long-term value in the business.

Shares in translation services provider RWS rallied after results showed a modest return to revenue growth in the second half of the year as some of its artificial intelligence initiatives started to pay off.

Activity

This quarter was a quiet one for activity, with no new positions.

In October, we trimmed our holding in construction company Morgan Sindall following strong performance, then in November we sold out of Quanex (we inherited a small holding in this US-listed business after the acquisition of Tyman, a supplier of components used in windows and doors) and reduced our holding in drinks maker Britvic (which is in the process of being taken over by Carlsberg).

The money was recycled into numerous existing holdings.

Outlook

Investor sentiment has taken a hit following increases to corporate taxes announced in the Budget. The fear now is stagflation: no economic growth and higher inflation as companies try to recoup additional national insurance costs by raising prices. However, we remain optimistic going into 2025. This is the last time the current government can (credibly) blame the previous one for unexpected funding gaps. Consumers are generally in good shape, with full employment and decent wage growth leaving them with spare income.

The issue has been a lack of confidence in spending this extra money; instead, people have been saving it. While we acknowledge the risk of job losses as companies seek to recoup higher taxes by cutting costs, this is likely to be more than offset by rising consumer spending as confidence improves.

Higher government spending will also help underpin a strong domestic economy. We believe this scenario should lead to healthy returns from UK smaller companies which have been languishing in an unloved part of the market.