Artemis UK Special Situations Fund update

Andy Gray and Henry Flockhart, managers of the Artemis UK Special Situations Fund, report on the fund over the quarter to 31 December 2024.

Andy Gray

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

Review of the quarter to 31 December 2024.

The long-awaited UK Budget and US presidential election influenced markets in the final quarter, with contrasting impacts on sentiment. The Budget was mostly a case of 'risks avoided' for the portfolio, with many of the speculated measures – such as additional bank taxes – failing to materialise. That said, hopes have been dashed that the Budget would act as a ‘clearing event’ for sentiment towards UK equities, due to concerns over the risk of rising unemployment and the inflationary impact of the employment tax increases. The contrast is stark with the US, where the election victory for Donald Trump has re-kindled animal spirits, overcoming – for now – any concerns over tariffs or the budget deficit.

Against this backdrop, the fund made 1.7% over the quarter, outperforming its FTSE All-Share and IA UK All Companies sector benchmarks, which fell by 0.4% and 1.3% respectively.

  Three months Six months One year  Three years  Five years
Artemis UK Special Situations Fund 1.7% 3.4% 13.0% 16.5% 33.0% 
FTSE All-Share TR -0.4% 1.9% 9.5% 18.5% 26.5% 
IA UK All Companies NR -1.3% 1.0% 7.9% 5.0% 15.2% 
Past performance is not a guide to the future. Source: Lipper Limited/Artemis as at 31 December 2024 for class I accumulation 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. Classes may have charges or a hedging approach different from those in the IA sector benchmark.

Stock positives

Our bank holdings – Barclays, Standard Chartered and NatWest – remained strong contributors to performance. Third-quarter results confirmed the progress being made in improving returns for all three.

Interim results from Jet2 were significantly ahead of market expectations, with strong customer demand close to departure dates. Capacity growth of about 9% is expected this summer. With pricing stable, 2025 should be another year of growth for the business.

Imperial Brands released full-year results that were ahead of expectations. Sales of reduced-harm products continue to surprise to the upside, leading investors to revise their views on the longevity of the company’s cashflows.

We have for some time felt the strong balance sheet of FirstGroup gave it options and we were pleased to see it put this to good use with its acquisition of London bus business RATP London. The deal goes some way to filling the profit gap from rail contracts which are set to be nationalised over the coming years.

Stock negatives

Detractors in the period were dominated by holdings affected by the tax increases and 6.7% hike in the minimum wage announced in the Budget. The impact on earnings will be most keenly felt by businesses with high numbers of lower-salaried employees, in sectors such as retail and hospitality. It will be least manageable for smaller or less profitable operators.

In contrast, we own leaders in these markets that have demonstrated an ability to handle these pressures while their smaller peers are starved of profitability. Our holdings have shown good progress in managing margins during the higher inflationary period of the past couple of years and we expect them to navigate this latest challenge just as successfully.

Activity

We maintain a robust pipeline of new ideas that is creating a healthy tension in the portfolio as investments ‘compete’ for capital.

We have regularly discussed housebuilders for the last 18 months or so, but until now, valuations have put us off. However, weakness across the sector has resulted in what we see as an attractive entry point and in October we initiated a position in Barratt Redrow, the UK's largest housebuilder. Barratt has been a consolidator of the sector over many cycles and the recent acquisition of Redrow strengthens its leadership.

The combination offers the opportunity to improve Barratt's return on assets as it adds Redrow's higher specification, higher average-selling-price product to its land bank. There will also be cost and procurement synergies. The UK housing market has been subdued during the recent period of higher interest rates, but is showing signs of a pick-up. A recovery is required to get anywhere near the government’s new homebuilding target, hence the recent change in planning regulations to improve supply.

Lloyds Banking Group has long been seen as the 'quality' UK bank due to its higher returns over the past decade, yet the recent car-finance commission review, where it has more significant exposure than peers, has weighed on the share price. We see any potential charge as manageable as Lloyds is over-capitalised, offering the potential for enhanced returns to shareholders once the issue is resolved. The bank benefits from many of the same earnings-growth dynamics that NatWest is set to enjoy, with the added potential from its nascent wealth management business. With the scales of valuation now tipped in Lloyds' favour, we have initiated a position using the proceeds from a reduction in NatWest shares.

Direct Line was the subject of two takeover bids last year. The most recent was by Aviva at 275p, in a mix of cash and shares. We like the deal. The new management at Direct Line was already in the process of a root and branch overhaul of the business, which can now be accelerated and de-risked under Aviva’s ownership where the systems and processes are already in place. Aviva is effectively buying two well-established consumer brands (Direct Line and Churchill) and the Green Flag rescue business. The cost savings will be significant. We started a position in Direct Line when the initial approach was announced, before adding a holding in Aviva when the higher offer of 275p was agreed and the likelihood of the deal increased.

Outlook

Optimism is not in abundance in the UK stock market. Low forecast GDP growth, persistent inflation which is leading to stubbornly high interest rates, and the lack of a catalyst to re-connect UK valuations with the rest of global equities all represent headwinds. At least UK equity fund flows seemed to have finally stabilised towards the end of the year, offering some comfort. The fund performed well in 2024, despite the lack of interest in our asset class, and we see no reason why we can't deliver again in 2025. The de-rating of quality UK stocks is an opportunity we plan to take advantage of.

We continue to invest with a contrarian mindset and a total return focus. Despite its outperformance, the fund is almost as cheap as it was a year ago. Profits have grown, company turnarounds are working and we continue to manage the portfolio with an eye on value. These factors, coupled with the expectation of ongoing delivery from our holdings, give us confidence in the potential for further strong returns in the year ahead.

Benchmarks: FTSE All-Share Index TR; A widely-used indicator of the performance of the UK stockmarket, in which the fund invests. IA UK All 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.

Andy Gray

Manages:

‘UK special situations‘ strategy

Andy works alongside Henry Flockhart managing Artemis’ ‘UK special situations’ strategy.

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Henry Flockhart

Manages:

‘UK special situations‘ strategy

Henry works with Andy Gray managing Artemis’ ‘UK special situations’ strategy.

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