Artemis Income Fund update

Source for all information: Artemis as at 30 June 2024, unless otherwise stated. The fund aims to grow both income and capital over five years. 

The largest technology companies led global shares upwards once again in the second quarter. Hopes that US inflation is falling and signs that economic growth is beginning to normalise propelled global stockmarkets to new highs.

The UK was one of the best performing markets globally, with the FTSE All Share returning 3.7% over the quarter. The economic headlines have continued to improve, with inflation falling and first-quarter growth being revised up.

The calling – and conclusion – of a general election which saw the Labour party winning a majority turned out to be something of a non-event for financial markets. In fact, the managers of many of the companies we hold have commented on constructive engagement with what appears to be an increasingly pro-business and fiscally sensible Labour party. In comparison with other parts of the world, such as France, which looks to be set for political paralysis after a snap election ended up in a hung parliament, the UK looks to be relatively stable from a political perspective.

Performance

Our fund returned 3.2% over the quarter, underperforming both the FTSE All-Share index¹, which rose 3.7%, and the average fund in the Investment Association’s UK Equity Income sector², which returned 4.6%.

For full five-year discrete performance, please see the table below. Please remember that past performance is not a guide to the future.

On the positive side…

3i boosted by Action

An update from 3i revealed yet more robust growth from discount retailer Action, in which it has a 55% stake. Like-for-like sales growth of 9% and net new store openings of 107 year to date (vs. 84 for the same period last year) reaffirms the pace and quality of the rollout of Action’s highly successful format. Action’s approach of passing on price reductions to consumers is a key component of the company’s value proposition and the outstanding growth in cashflow (the money left over after all liabilities have been paid) it has been able to deliver.

3i has been a key contributor to portfolio returns since we invested more than 10 years ago, with dividends per share increasing fivefold over this period. Action’s management team believe that its store footprint can still triple in Europe, which suggests to us that this rollout (and resultant growth in cashflows) has some way to go yet.

Banks experience robust performance

NatWest shares – and indeed other UK banks – have been performing well. NatWest’s share price has climbed by almost 50% so far this year, illustrative of investors waking up to the high cash returns on offer and the effect of share buybacks3 at low valuations. Interest rates are likely to have peaked, but as long as they do not return to zero (a scenario that looks increasingly unlikely) the earnings power of a bank is transformed. Furthermore, earnings should be supported by the structural hedge – a proportion of a bank's portfolio that is invested in fixed income instruments to smooth earnings volatility. As these instruments roll off and are invested at higher rates (much of the hedge still yields 0.5%), the aggregate yield of the hedge (and its effect on earnings) will increase, with analysis suggesting that the benefit to earnings from the hedge could amount to several billion pounds over the next two to three years.

Imperial Brands

Imperial Brands’ turnaround under its (relatively) new management team continues, with debt being reduced, market share stabilising and price increases offsetting volume declines. Tobacco still looks to be structurally challenged, but execution on this turnaround plan has thus far been strong which has helped to lift the share price. Imperial is one of many UK companies engaged in significant share buybacks. These buybacks – combined with an 8% dividend yield – look very attractive, but we remain cognisant of the pressures on the industry.

On the negative side

Food retailer SSP’s shares have been weak this year, reflecting the market’s lack of confidence in its investment plans. We remain positive and have been adding to the position.

EasyJet’s recent results were fairly solid, with yet more strong performance from the holidays business and a confident tone from management around achieving the target of over £1bn profit before tax. Demand has remained resilient too, with passenger growth of 11% in the first half of the year. However, the shares were dragged lower by the unexpected announcement that chief executive Johan Lundgren will depart in early 2025 (and be replaced by Kenton Jarvis) and guidance from industry peer Ryanair that growth in summer fares will be more modest than expected. We remain of the opinion that easyJet shares are attractive.

Pearson’s shares have been rather subdued recently, but we believe the longer-term story is still compelling. We see several parallels between Pearson today and RELX and Wolters Kluwer (two of our most successful investments) almost a decade ago when these businesses embarked on their transformative transition from print to digital.

Activity

We added to Tesco. Its competitive position continues to strengthen, at the expense of several industry peers that are suffering from high debt loads. We also expect the company to buy back around 8% of its shares over the next 12-18 months.

We also added to Legal & General. A safe, 9% dividend yield that should grow at mid-single digits looks attractive, as does the announcement of a share buyback.

Finally, we added to electricity company SSE. We believe the market underestimates its structural growth opportunity as a beneficiary of decarbonisation and growing demand for power.

We reduced 3i and RELX, given strong share price performance, and sold Boliden and Indivior.

Outlook

The relative political stability of the UK today would have been difficult to imagine a short while after the tumultuous events of late 2022. Yet here we are, with a Labour government with a convincing majority that has so far sought to reassure both the public and investors about the importance of fiscal discipline. What is also important to consider is the UK’s political stability relative to other parts of the world, particularly Europe and the US where the future course of both domestic and foreign policy looks highly uncertain.
If we combine this stability with an economy that has already performed better than widely expected, and a consumer that remains in reasonable health with a high savings rate, we think the set-up for the UK looks compelling.

The fact that an increasing number of international investors are showing up on UK shareholder registers – not just in the larger global businesses listed here in London but also in the more domestic areas of the market – suggests that sentiment behind the much-derided UK is beginning to change. This also corresponds with the recent acceleration of bids for UK companies, a trend we believe will continue given a UK market which in large parts remains materially undervalued versus international peers. Buybacks remain a powerful catalyst, too, with record numbers of companies buying back their own shares. As a result of these factors, we see tangible evidence that the conditions surrounding the UK equity market are beginning to improve.