Artemis UK Special Situations Fund update

Source for all information: Artemis as at 31 March 2025, unless otherwise stated.

Review of the quarter to 31 March 2025

The post-US election rally reversed in the first quarter of the year, with the unorthodox approach of the new president causing considerable uncertainty for governments, management teams and investors alike. One immediate outcome has been a marked increase in European defence spending, with the new German coalition proposing reform of the constitutional debt brake and the EU commission loosening deficit rules to accommodate it.

In comparison, the UK was relatively quiet. The chancellor’s Spring Statement required some welfare cuts to meet her fiscal rules against a weaker economic backdrop for the UK, while the Monetary Policy Committee cut interest rates by 25bps, with further reductions expected.  

The most striking aspect of the UK market in the year to date has been the outperformance of large caps. On a total return basis, the FTSE 100 rose by 6.1% in the quarter, compared with a loss of 5.0% for the FTSE 250. In the early days of the year, this made sense, with higher bond yields and a weaker currency putting more pressure on domestic earners, but these have since reversed, while the gap remains. This large-cap outperformance has been mirrored in other markets. 

This leaves the FTSE 250 trading at an unusual forward price-to-earnings (P/E) discount to the FTSE 100, despite better growth forecasts. Therefore, it should not be surprising that we are seeing more opportunities in this area of the market and are reallocating capital accordingly.

The fund rose by 0.2% during the period, compared with a gain of 4.5% from its FTSE All-Share benchmark.

Detractors

Reinsurer Conduit released a disappointing update, with Los Angeles wildfire losses higher than expected. Management responded by purchasing additional reinsurance to protect the business during hurricane season and deliver a positive return-on-equity (ROE). While disappointing, we see significant value in the shares, trading as they do at a sizeable discount to a growing book value.

Our UK consumer-facing mid-cap stocks faced a more difficult quarter despite reporting trading that has generally been robust. Jet2 expects to deliver profit growth of 8 to 10% this year while Mitchells & Butlers reported like-for-likes up more than 10% during the peak Christmas period. Watches of Switzerland has seen revenue stabilise in the UK and continued positive momentum in the US, helped by the recent acquisition of jewellery brand Roberto Coin. All have de-rated. So too have B&M and Whitbread, for which current trading has been more difficult, although their downgrades have been limited to single digits.

With electric vehicle growth stalling, inventory has built up in the supply chain, affecting demand for Morgan Advanced Materials’ silicon carbide products. It has adjusted future capex plans accordingly. Management is taking further action to cut costs in a bid to deliver 12.5% margins – the lower end of the target range.

In our view, bookmaker Entain has turned a corner operationally, so it was disappointing to see the departure of the recently recruited chief executive, Gavin Isaacs. That said, we have high regard for chair Stella David who will once again take on an executive role. It was under her leadership in 2024 that the business made significant progress with both the Entain and BetMGM businesses benefiting from product improvements.

Contributors

Babcock has benefited from increased defence spending across Europe, but self-help is also improving the quality of the business. A positive trading update led profit expectations to be upgraded by more than 10%, with the nuclear services division the standout performer. The company remains on track to deliver its medium-term targets, including 8% margins and mid-single digit growth. These were set in a world where UK defence spending stood at 2% of GDP, so we see substantial upside.

Our bank holdings are building a track record of consistent delivery, with another strong reporting season. Standard Chartered and Barclays both announced 2024 results were ahead of expectations, are progressing towards their higher ROE targets and are taking advantage of low valuations to buy back stock below book value.

Next delivered a strong Christmas trading update, followed by a profit upgrade at the end of March. Strong international sales are helping the company navigate cost headwinds and deliver ahead of expectations.

Smiths Group announced a long-mooted breakup of the business. It will sell the Interconnect division in 2025, before selling or demerging the Detection business. ‘FutureSmiths’ will comprise John Crane and Flex-Tek – the higher-growth, higher-margin divisions. New targets, including margins of 21 to 23%, growth of 5 to 7% and return on capital employed (ROCE) of more than 20% reflect the quality of the retained businesses. We have engaged with the board and management on numerous occasions over the valuation potential of Smiths Group and support the recent announcement.

Aviva reported strong results and set out a vision of its customer-centric strategy (with a base of more than 20 million customers) following its acquisition of Direct Line.

Purchases

We added one new holding in the quarter: On the Beach. For many years, the online travel agent has been taking share in the holiday market by packaging low-cost flights, from the likes of Ryanair and easyJet, with hotels. The hotels like the model because it drives customers to their destinations and the airlines should like it because it drives passenger growth.

However, Ryanair resisted the model for a long time as it preferred a direct relationship with customers. This crystalised into a standoff in 2024 where online travel agents were banned from accessing Ryanair flights. During this time, Ryanair’s bookings suffered as it became apparent that the likes of On the Beach were an important source of customers. In the end, a new partnership was signed.

The new deal will deliver an improved experience for customers and allow On the Beach to reduce costs. The bigger opportunity, however, lies in the potential for expansion. The launch of city-break packages and entry into Ireland will more than double the addressable market. A new £85 million medium-term profit-before-tax target compares with £31 million in the 2024 financial year. With £97 million of the £350 million market capitalisation in cash and the company trading on less than 10x 2026 earnings per share, we see significant upside.

We continued to build our positions in Aviva, WH Smith, Lloyds and Barratt Redrow and added to Entain following the improved operational delivery highlighted earlier. We also topped up Watches of Switzerland, Grafton, Hill & Smith, Unilever and Oxford Instruments on share price weakness.

Sales

We exited three holdings in the quarter.

First up was Computacenter, which had been a holding since 2012 when an onerous contract in Germany led to a sharp sell-off in the shares. Since then, the business has grown consistently and expanded into the US, making it one of our strongest contributors.

However, the business has now become more dependent on a small number of very large customers, making results potentially more volatile. We see increased risk of a trading downturn.

Having reduced our position in Howden Joinery during 2024, we sold the remaining 0.5% holding in the quarter. Howden continues to win market share, but the market backdrop remains tough, and the share price performance was at odds with the operational momentum in the business.

We also received the final cash proceeds from the acquisition of Britvic by Carlsberg.

Within the banking sector we have been building a position in Lloyds, but are mindful of our overall sector exposure, so have been funding it with the sale of NatWest and trimming our holdings in Barclays and Standard Chartered.

We have taken profits in Imperial Brands in recent months. The company has been transformed under Stefan Bomhard, but we are conscious that US volume trends remain weak and Imperial’s next-generation portfolio is at an early stage. In addition, we have noted competitor Altria (the owner of Marlboro) has raised prices but has suffered significant market share losses as a result. With Imperial Brands' shares having re-rated, we feel the risk/reward is more balanced so have been reducing the weighting accordingly.

We also took profits in Babcock, Intermediate Capital Group and Tesco and trimmed GSK and Bodycote.

Outlook

News of Donald Trump imposing high tariffs on the US’s trading partners is fresh off the press. While the initial high figures were soon postponed and reduced for every country apart from China, they will still be damaging to global trade flows. For example, the US accounts for 15.3% of the UK's export goods¹.

From a stock market perspective, the impact will be far reaching. A recession in the US is more likely, and trade will be disrupted globally. This will affect demand. Hence the flight to safety, with a weakening in share prices and a rally in short-duration bonds fully warranted. In the UK, interest rates may be cut faster than previously anticipated.

There will be some direct impact on our holdings. For example, 45% of Watches of Switzerland’s sales are to the US, so it will need to increase prices to offset tariffs, potentially affecting demand. Yet this is on a P/E of just 8.7x. And while trade flows in South-East Asia may be disrupted, leading to reduced revenues for Standard Chartered, the bank is on a P/E of just 7.1x.

On the positive side, the pound has strengthened. A reduction of goods purchased by US consumers will mean these products need to find alternative markets. This is positive news for UK retailers, which will be able to pick them up on the cheap. We own shares in Next, Dunelm, DFS, Tesco and B&M. The initial reaction has been higher share prices. Periods of disruption and dislocation are normally profitable times to invest with a contrarian mindset and we will continue to make investment decisions based off a medium-term time horizon. The investment case of each holding is focused on self-help initiatives driven by management teams that can deliver value for shareholders.