Artemis US Select Fund update

"Higher for longer"

Investors' focus for much of the quarter was on the prospect of easing inflation and where the Federal Reserve would take interest rates. As the quarter began, the prevailing sentiment was that a 'soft landing' would allow the Fed to cut rates towards the end of 2023. By the time it drew to a close, however, it had become clear that certain elements of inflation - particularly wage inflation - were proving more persistent than had been hoped. In response, the central bank signalled that rates would need to remain higher for longer, which contributed to the S&P500 having its worst month of the year during September.

Deconstructing the index's return over the quarter, sectors that are sensitive to changes in interest rates came under the greatest pressure. As such, utilities and real estate were the key underperformers, returning -5.5% and -5.1% (in sterling terms) respectively. Yet while most sectors ended the quarter lower, energy and communication services bucked the downward trend, returning 16.9% and 7.4% respectively.

Strong stock selection drives fund performance….

Over the quarter, the fund returned 2.6% (in sterling terms) while the S&P 500 Index returned 0.8%. It was encouraging to see stock selection underpinning that outperformance. The market is increasingly focusing on the fundamentals of individual companies rather than solely on 'factors' (such as 'growth' and 'value') whose dominance had resulted in wild swings between different categories of stocks in previous quarters.

Positives

Constellation Energy - This nuclear power/clean energy supplier is one of our highest-conviction holdings. So we were pleased to see our thesis continuing to play out over the quarter. Good news on earnings is being driven by its customers' willingness to pay more given volatility in energy prices and, perhaps more importantly, by the fact that Constellation is seen as a reliable supplier. Its reliability and focus on clean energy also make it an indirect beneficiary of the AI wave as energy-intensive data centres are being built in the states that Constellation serves.

Meta - Even before the company released consensus-beating earnings for the second quarter, our investment thesis had begun to shift from Meta being a contrarian turnaround story to an outright growth story. Its near-term recovery is increasingly well understood. The benefits of Meta's cost cutting are clear and the market now appreciates that that the deceleration in its growth was due to its pivot to Reels (a short video format) and a transitory loss of ad efficacy due to Apple’s privacy changes.

In our view, however, the durability of its core business and the new growth opportunities that lie before it are still being underestimated. From this point, we think investors will begin to appreciate that Meta’s significant incremental investment in AI and datacentre infrastructure will lead to meaningful new revenue opportunities both through growing in its existing markets as well as in entirely new product categories.

Negatives:

Dexcom - Excitement about the potential for novel 'GLP-1' diabetes drugs sent Dexcom's shares lower. Novo Nordisk and Eli Lilly both have drugs that not only treat Type 2 diabetes but can also be used to treat obesity. Novo Nordisk released data showing that these drugs could also be used to lower certain cardiovascular risks, because of weight loss. As the market believed these drugs would be more widely adopted, they also believed that the use of other tools to manage and treat diabetes, like pumps and CGMs (continuous glucose monitors) would be lower. We believe that this is not the case; rather, CGMs have a role to play in helping manage the adoption of these new GLP-1 drugs. Indeed, in early September Dexcom published data regarding the increase in adoption of CGMs by patients who are on GLP-1 therapy. We see the sell off in Dexcom as overdone and continue to hold the stock.

CSX - Freight company CSX underperformed over the quarter as weekly shipping volumes failed to show the increase that had been anticipated. In addition, the company announced that its chief operating officer was leaving. This is an important role in this business and the stock was hit on the day of the news. CSX subsequently announced it had hired an experienced replacement to fill the vacancy.

Less-than-truckload holdings receives a boost…

We have written about our holding in Saia, a 'less-than-truckload' (LTL) freight company, before. We recently added more exposure to this subsector with the purchase of TFI International (TFII). For Saia, we have been constructive for a long time in their ability to work towards being a best-in-class national carrier, which should result in both higher revenue and better profitability. In the case of TFII, we see a major opportunity to improve the profitability of the LTL business it acquired from UPS.

During the third quarter, there was a major change in the less-than-truckload industry. Yellow Corp (formerly a top five carrier by revenue and volume), filed for bankruptcy following years of financial challenges. Typically, LTL bankruptcies end up being a liquidation process, rather than a reorganization process. Customers (shippers) tend to leave at the first sign of trouble: nobody wants their freight sitting by the roadside in the middle of nowhere. Technically, Yellow is currently under a reorganization process, rather than a liquidation process - but it seems to have played out in a fairly similar way to outright bankruptcy, with drivers being laid off and terminals closed. Yellow's freight is now being shipped by other companies. Based on intra-quarter conference calls and regulatory filings, we believe both of our holdings have seen a good sequential step up in volumes. We are hoping to see a positive impact on pricing (as capacity has been removed from the industry) and profitability (as networks that were underutilized during the economic downturn were well positioned to accept new volume). Third quarter results from Saia and TFII should be very interesting.

Transactions

During the quarter, we started a position in Blackstone, a leading alternative asset manager. We believe there are a number of attractive growth drivers for the private asset industry, and Blackstone's brand and investment track record position it very well for continued strong asset gathering.

Blackstone's mix of business also provides a level of comfort against an uncertain backdrop. Its real estate business would benefit if interest rates fall while its credit business has seen outsized growth in a higher rate environment. As the IPO market continues to recover, we expect deal activity to return.

We sold Kraft Heinz as the pricing power it attained during and after Covid appears to be ebbing away. Most of our other sales were taking profits after strong runs over the year to date, in particular Constellation Energy.

Outlook

There are risks on the horizon as the market contemplates higher-for-longer rates and their likely chilling impact on economic growth. The index has performed well over the year to date, but there has been huge dispersion in stock returns beneath the headline return. We believe this will continue to present active managers with an opportunity to find mispriced businesses. For example, we continue to see value in the life sciences space which has struggled this year owing to near term cyclical concerns. The next key event in our calendars is the third-quarter earnings season. We will be looking closely for signs that order trends for our life sciences companies are bottoming out, along with evidence of improved profitability at our trucking companies following the bankruptcy of Yellow Corp.