How Artemis’ fund managers are investing post-Budget

A cartoon in The Telegraph on 31 October summed up many UK investors’ initial reaction to the previous day’s events, saying: “Now I’ve seen the Budget details, I no longer think uncertainty is the worst thing for businesses.”

It was certainly difficult to find much to cheer: subjecting pensions to inheritance tax and hiking capital gains tax will hit some investors directly, while a far greater number are likely to suffer indirectly as many companies face rising costs from the increase in national insurance contributions and a decrease in the level at which they kick in.

But now the initial emotional reaction has died down, there are signs that the policies announced in Rachel Reeves’ first Budget won’t be as negative for the UK market as investors first feared. And – whisper it – some sectors may even stand to benefit.

Changes to national insurance

First up, the bad news. Henry Flockhart, co-manager of the Artemis UK Special Situations Fund, said the hike in national insurance contributions will be felt most keenly by labour-intensive companies whose employees are on modest wages. These include retailers and service-led leisure businesses such as pubs and restaurants.

Yet this is not necessarily a reason to avoid these sectors. Ed Legget and Ambrose Faulks, managers of the Artemis UK Select Fund, said the market leaders in these areas will have the option to “pull the price lever”.

“In industries such as retail and hospitality, it is hard to have materially different labour costs – but what will make a difference is the quality of the franchise,” they explained.

“We have seen through the Global Financial Crisis, Covid and the cost-of-living crisis that those with the strongest franchises will have the highest margin structures and the most attractive assets, so are far better placed to absorb any costs they cannot pass on.”

They added: “For weaker/smaller businesses already struggling in these sectors, we would expect to see an acceleration in capacity exiting (from competitors leaving/failing) over the next 12 to 24 months, benefiting the remaining incumbents. Hence, we are relaxed about the Budget’s impact on our holdings in companies such as Next, Whitbread and Mitchells & Butlers.”

Unintended consequences of the Budget

While changes to national insurance will have a direct impact on sectors such as retail and hospitality, the indirect impact will be felt across the wider economy.

William Tamworth, co-manager of the Artemis UK Smaller Companies Fund, is reasonably optimistic about consumer-focused stocks, noting that real wages are growing¹ and excess savings built up during Covid remain unspent².

However, he said that if the cost of changes to national insurance are passed on to customers as expected, it will have an inflationary effect – as will the increase in public sector spending and the 6.7% hike in the minimum wage³.

The Office for Budget Responsibility (OBR) is now predicting that CPI will bounce back to 2.5% in 2025 and will remain above the Bank of England’s 2% target until 2029.

Legget said this “aligns with our view that the Bank will struggle to cut rates aggressively from here”.

According to Tamworth, this will result in a very different environment to the decade that followed the Global Financial Crisis, when the era of quantitative easing favoured a growth-at-any-price mentality.

“Our conclusion: valuations are likely to matter and companies with pricing power will be attractive,” he added.

In terms of sectors, Legget and Faulks said higher interest rates will be negative for housebuilders and REITs (real estate investment trusts), but positive for banks as their structural hedges⁴ roll over at higher levels.

Which sectors benefited from the Budget?

This is not the only way that banks benefited from the Budget – they appeared to be boosted by what wasn’t announced by the chancellor, as well as what was.

There had been fears that banks, along with bookmakers and oil & gas companies, would be hit with new windfall taxes, so there was relief in all three sectors as the first two escaped unscathed and the third saw a much lower increase than expected.

Andy Marsh and Nick Shenton, co-managers of the Artemis Income Fund, said that this suggested that the government “has well and truly got the message with respect to the importance of the corporate sector in furthering its pro-growth agenda”.

“Though there are some headwinds for business, in the round it can be said that Labour has been true to its word in recognising the importance of the corporate sector in the fortunes of the UK economy,” they said.

“Hopefully, focus can return (again) to a UK economy that continues to perform better than expected and an equity market that remains undervalued versus international peers.”