Artemis European Sustainable Growth Fund update

We are proposing to change the name, investment policy and strategy of Artemis European Sustainable Growth Fund. An extraordinary general meeting will be convened at 10:00am (UK time) on 1 August 2023. If the proposal is approved by unitholders, the effective date of the changes will be 14 August 2023.

The fund returned 1.5% in the second quarter compared to a 0.6% return in the FTSE Europe ex UK. Year to date the fund has returned 7.4% compared to a 9.3% return in the index.

In absolute terms, the fund's top three contributors were Dino Polska, Edenred and Amadeus. Our top three detractors were Ipsos, Sartorius Stedim, and FinecoBank. In broad terms, relative outperformance in the quarter was driven primarily by sector selection with the fund holding no exposure to telecoms and food/beverages.

Key developments affecting markets and the fund in the quarter were as follows:

• Q1 corporate earnings – were generally more robust than expected with the exception of some industrial sectors (such as chemicals), where de-stocking of inventory has led to a sharp decline in volumes

• Declining headline inflation – deflating input costs noted last quarter have fed through to lower headline inflation (e.g. Spain is < 2%) and a peaking in core inflation. It remains uncertain as to whether the persistence of high services inflation is due to stickiness or it being a backward-looking indicator.

• Artificial intelligence – has become a dominant stock-market theme, following Nvidia’s reporting extraordinary Q1 results, leading to a rally in US technology indices, led by a few large stocks.

• Path of interest rates – remains uncertain, as economies have proven more resilient to higher interest rates than expected (notably in the UK), and central banks are determined to reassert credibility. The last point explains the mismatch between fundamentally strong economic data (e.g. low unemployment) and weak consumer/investor confidence as expectations fluctuate over whether a 'hard' or 'soft' landing is necessary to bring inflation back to target.

A favourable feature of Continental European economies is that they have greater slack in labour markets. For this reason, long-term expectations for interest rates in Europe have been less volatile and lower in absolute terms than the UK or US.

This has created a more favourable set up for European banks than in other regions as banking deposits are likely to be more inert at low absolute interest rates (< 5%) and interest rates have not risen to the point at which the income benefit is outweighed by higher credit costs due to the damage to collateral values. Our objective is not to position the fund to benefit from a particular macroeconomic outcome, but to ensure that our exposure to risk and judgement of returns reflects an evolving environment.

In the quarter, turnover remained high as we continue to execute on our revised strategy.

We sold a number of medical equipment companies (Sonova, Sartorius, Coloplast, and Biomerieux). Valuations remain high in absolute terms (20x-30x PE), reflecting characteristics of defensiveness and stable structural growth. However, our concern was that this failed to reflect the risk that the earnings base have been distorted by the pandemic pull-forward of demand. Q1 numbers suggested this was the case with some material profit warnings in the sector.

We started a number of new positions with weightings of 1-2%. Frasers Group is a dominant UK sportswear and luxury retailer where we feel that pessimism towards the UK economy has created a compelling opportunity. Elis is a dominant flat-linen and commercial laundry business with a track record of stable margins. The company continues to benefit from the recovery in services. IMCD is a speciality chemical distributor, which offers a less operationally geared exposure to industrial chemicals. Cairn Homes is a leading housebuilder in Ireland, where there is an acute shortage of housing, and rates remain supportive to volumes. Existing positions were increased in Munich Re, Azelis, Unicredit and UMG. Holdings were reduced in Hermes, Dino Polska, and Finecobank. We sold Teleperformance as we felt that artificial intelligence will be a persistent risk to business volumes.

The fund’s core positions in growth staples (L’Oreal, Novo Nordisk, EssilorLuxottica) and software (SAP, Wolters, Dassault) have low fundamental risks and offer reasonable returns given visible growth prospects. Earnings potential in financials (banks and reinsurance) has risen significantly as a result of higher interest rates but has arguably not been reflected in valuations. Our industrial exposures (chemical distribution and infrastructure) offer exposure to an improvement in economic conditions with limited risk of operational gearing.

In aggregate, we are optimistic, as we continue to see attractive prospective returns from a diverse range of sources.

Munich RE

We bought a holding in Munich RE in Q1 and added to it in Q2 and it is now a top 10 position. Munich Re is the largest player in the global property and casualty reinsurance industry. The fundamental case for the reinsurance sector has strengthened because a dislocation between capital supply and insurance demand has developed, due to a combination of cyclical and structural factors resulting in higher risk-adjusted pricing. Munich RE trades on 10x 2023 earnings and offers a dividend yield of over 4%, supplemented by c.2% distributions via share repurchases. The company’s low valuation reflects scepticism by the market that positive conditions will persist.

Epiroc

The fund holds a 2.9% position in Epiroc, a Swedish mining machinery company. It trades on 23x earnings and has a dividend yield of 2%. The investment case for the sector has been improving over recent years, due to capital underinvestment. There has been a lack of investment in mining over a multi-year period following a drastic downcycle in the early 2010s. Spend on mining machinery remains at less than half of peak levels, near 15-year lows. There is also growing demand as the green energy transformation will increase demand for minerals. For example, an electric car has more than double the amount of copper than a conventional car.
Epiroc’s offering also positions it well to capitalize on miners’ focus on improving sustainability. Lower-emission and cable-powered machines make up over 30% of sales. Today, Epiroc has electric versions of c.40% of its machines, but that is set to reach 100% by 2030.