Artemis UK Smaller Companies Fund update

Mark Niznik and William Tamworth, managers of the Artemis UK Smaller Companies Fund, report on the fund over the quarter to 31 December 2024 and their views on the outlook.

Mark Niznik

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

Review of the quarter to 31 December 2024.

The Artemis UK Smaller Companies Fund fell 3.2% in the fourth quarter of 2024, compared with losses of 1.2% from its Deutsche Numis UK Smaller Companies (-InvTrust) benchmark and 2.1% from its IA UK Smaller Companies sector average.

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-margin companies (which are easy to identify) without pricing power (which are more difficult to ascertain).

We are wary of the hyperbolic headlines seen since the end of October. Consumer, business and investment sentiment can change quickly and we continue to believe that the macro picture is better than commonly reported and that the narrative surrounding the UK is at an inflection point.

Negatives

Three Court of Appeal decisions relating to motor finance 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 Vanquis and Secure Trust Bank.

The latter of these was the biggest contributor to underperformance during the quarter, falling by 55.9%. Aside from a potentially large compensation bill, it also issued a profit warning driven by a slower recovery in its vehicle finance division, after the FCA’s Borrowers in Financial Difficulty (BiFD) review led to a temporary pause in collections and a higher default rate. However, the shares are now trading at a 75% discount to book value and offer substantial potential upside in compensation for the undoubtedly high risk.

Serco lost a large contract for Australian immigration services, while the increases to national insurance contributions and the minimum wage announced in the Budget prompted a 9% cut to 2025 earnings. We added to our position.

Videndum, which provides hardware and software to the film industry, announced a large profit warning 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”; £25 million worth of share buybacks; and a new five-year plan implying profit growth of 20% a year. While the valuation of On The Beach does not look stretched, we took some profits after its shares rose by more than 80% during the quarter to stop it becoming an oversized position in the fund.

Beeks Financial Cloud’s solid results were superseded by comments about “several major international exchanges entering the final stages of contracting”. These contracts, combined with the exchanges already won, could transform earnings over the next few years. We took some profits here, too.

Eckoh, a leader in the provision of secure payments in customer service centres, became the 32nd holding in the fund to be the subject of a recommended takeover offer since the start of 2019. While the average premium stands at 47%, this was a frustrating reminder that many of the prices achieved represent no more than fair value: in this instance, the premium was just 11%. On our forecasts, the business is being valued on a March 2026 free cashflow yield of 5.6%. We struggle to see how this reflects the strong US growth potential, high recurring earnings and a strong balance sheet (with net cash).

Translation services provider RWS saw a relief rally after 2024 financial year results showed a modest return to revenue growth in the second half as some of its AI initiatives started to pay off.


 Three months Six months One year Three years Five years 
Artemis UK Smaller Companies -3.2% -1.9% 9.3% 5.1% 14.0% 
Deutsche Numis UK Smaller Companies (-InvTrust) TR -1.2% 3.8% 9.5% -1.0% 15.6%
IA UK Smaller Companies NR -2.1% -2.5% 6.3% -21.0%  4.1%
Past performance is not a guide to the future. Source: Lipper Limited to 31 December 2024 for class I Acc GBP. All figures show total returns with dividends and/or income reinvested, net of all charges. Performance does not take account of any costs incurred when investors buy or sell the fund. Returns may vary as a result of currency fluctuations if the investor's currency is different to that of the class. This class may have charges or a hedging approach different from those in the IA sector benchmark. 

Activity

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

In October, we trimmed Morgan Sindall on 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) and reduced our holding in Britvic (currently under offer from Carlsberg).

The money was recycled into existing holdings including Victorian Plumbing, Next 15, JD Wetherspoon, QinetiQ, Chemring, MJ Gleeson, TT Electronics, Halfords, Restore and Warpaint.

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 fuelling increased disposable 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, with government rhetoric changing to one that promotes future growth.

Higher government spending will also help underpin a strong domestic economy. This scenario should lead to healthy returns from UK smaller companies which have been languishing in an unloved part of the market. Our confidence comes from the low starting valuations in our holdings: overall, the median company in our portfolio is forecast to increase earnings by 10% in 2025 on an operating margin of 14% and a return on capital of more than 18%, with no debt. Yet it is currently valued on an 8% free cashflow yield. This feels to us to be a significant mispricing in an economy that is expected to grow modestly and where the interest rate cycle has turned.

Benchmarks: Numis Smaller Companies (-InvTrust) TR; A widely-used indicator of the performance of the UK smaller companies stockmarket, in which the fund invests. IA UK Smaller Companies NR; A group of other asset managers’ funds that invest in similar asset types as this fund, collated by the Investment Association. These act as ’comparator benchmarks’ against which the fund’s performance can be compared. Management of the fund is not restricted by these benchmarks.

Mark Niznik

Manages:

‘UK smaller companies‘ strategy

Mark has managed Artemis‘ ‘UK smaller companies‘ strategy since joining the firm in 2007, which he does alongside fellow manager William Tamworth

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William Tamworth

Manages:

‘UK smaller companies‘ strategy

William works with Mark Niznik managing Artemis’ ‘UK smaller companies’ strategy.

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