Artemis US Smaller Companies Fund update
Cormac Weldon and Olivia Micklem, managers of the Artemis US Smaller Companies Fund, report on the fund over the quarter to 30 September 2024 and their views on the outlook.
Source for all information: Artemis as at 30 September 2024, unless otherwise stated.
The quarter began with softer inflation data and the Federal Reserve expressing confidence that it would continue to fall towards their target of 2%, leading markets to interpret this as a clear sign of potential 'dovish' cuts in September. This caused a violent rotation in markets as investors reduced their negative bets on smaller companies. In the second week in July, the Russell 2000 index rose strongly.
However, by mid-July, signs of stress around the health of the US economy started to filter through to equity markets. These tensions were exacerbated at the start of August by a weaker-than-expected jobs report and a rise in the unemployment rate, triggering the Sahm Rule1, a key indicator of a recession. On top of these domestic concerns, the Bank of Japan’s decision to raise interest rates put pressure on global financial markets, particularly on the Yen carry trade—a strategy in which investors borrow in low-yielding currencies like the yen to invest in higher-yielding currencies. These events led to a complete reversal of the gains the index had experienced in the first half of July.
Despite these initial headwinds, by late August, more supportive economic data began to emerge, including stronger retail sales and better-than-expected weekly jobless claims in the US. These reports alleviated some of the immediate fears of an imminent recession, allowing the Federal Reserve to proceed with its first rate cut.
The Russell 2000 finished the period up 0.4%, (in sterling terms) and more interestingly slightly ahead of the S&P 500, an unusual occurrence in a time when the largest companies have been driving returns in the US.
| Three months | Six months | One year | Three years | Five years | |
|---|---|---|---|---|---|
| Artemis US Smaller Companies Fund | 0.4% | -4.6% | 22.1% | -0.5% | 49.4% |
| Russell 2000 | 3.0% | -0.5% | 15.3% | 6.2% | 43.9% |
| IA North America smaller companies average | 2.0% | -1.5% | 14.5% | 4.3% | 51.9% |
During this period, the fund underperformed the index returning 0.4% (in sterling terms) vs. the Russell 2000 index's 3.0%. Main detractors over the three months from a sector perspective were our holdings within technology and consumer discretionary. Partially offsetting weakness was our utility and energy exposure. Our holdings within these sectors have benefited from the broader pick-up in demand for clean energy, a theme we continue to be well-positioned in.
On the negative side, Elf Beauty suffered with the business revealing that sales trends fell short of the market's forecasts, causing it to revise down estimates over the quarter. Within our technology exposure, Western Digital underperformed as it is closely tied to concerns around AI-related capital expenditure. Despite near-term headwinds, we maintain our long-term positive outlook on the company, as its memory chips will be critical to AI infrastructure. Weatherford International, an oil services company that assists in drilling and maintaining oil and gas wells, was impacted by weaker oil prices and challenges within the energy services sector. We decided to sell the position and reallocate to opportunities with a more attractive risk reward. Finally, within our financials exposure, LPL Financial struggled with declining net interest margins. Clients moved cash from low-yielding accounts into higher-yielding alternatives, which negatively impacted profitability.
On the positive side, Vistra was the largest contributor to performance. The independent power producer benefits from its exposure to both gas and nuclear energy, which are increasingly in demand, especially from data centres seeking cleaner energy solutions. The decline in interest rates also provided a further boost to this capital-intensive industry.
Within our financials exposure Jones Lang LaSalle and Jefferies contributed. Both businesses stand to benefit from a pick-up in deal activity within property and capital markets respectively. Both have attractive idiosyncratic characteristics that make them more interesting opportunities than the more traditional financials within the US small and mid-cap universe which tend to lose out to their larger peers.
Within our industrials exposure, Axon Enterprise continued to benefit from strong demand for its body cameras and the new AI-driven report writing tool, which helps streamline law enforcement operations. Axon’s consistent revenue growth remains a key driver of its performance.
Activity
We made a number of changes over the period. We bought positions in companies set to benefit from tight supply-demand dynamics and long-term growth trends. For example, Kirby, a domestic barge operator, was added to the portfolio due to high utilisation rates and positive pricing. The fund also increased its exposure to Affirm Holdings, a leading "buy now, pay later" company, which is expected to grow alongside the expanding e-commerce sector. Additionally, we initiated a position in HudBay Minerals, a copper mining company well-placed to capitalise on the global energy transition towards renewables.
We sold the fund's positions in Weatherford International and Ralph Lauren. The decision to sell Weatherford was driven by persistent weakness in the oil services sector. In the case of Ralph Lauren, we concluded that the investment thesis had played out, and better opportunities were available elsewhere. The fund also reduced its holdings in Core & Main and Elf Beauty due to weaker-than-expected guidance and slower sales trends, respectively.
Outlook
As we emerge from the summer months that have been characterised by volatility both in markets and in estimations of the health of the US economy, we don’t feel that we are entering a period of calm in markets. Our process of identifying businesses with attractive risk-reward profiles has proved essential in guiding the fund through this volatile period. We have a clear framework around modelling the downside scenario in addition to modelling the upside. In times of volatility this is extremely helpful as you can immediately understand if there is overoptimism or undue pessimism.
We are acutely aware of the upcoming election, with each party representing quite different policy objectives. As we approach the date, we expect to be spending a significant amount of time modelling the different outcomes on a stock-by-stock basis to understand the implications.
To reiterate the case for US smaller companies…
- Their valuations relative to large caps are still at multi-decade lows.
- They are more domestically wired allowing us to capture the intricacies of American economy more directly.
- The breadth and depth of the market means that we can target specific themes such as housing shortage, AI investment, fiscal expenditure or onshoring more effectively.