Artemis Income Fund update

Source for all information: Artemis as at 31 March 2024, unless otherwise stated. The fund aims to grow both income and capital over five years. 

As readers will know by now, the portfolio’s prospects rest more on the individual characteristics of the shares we own, rather than the ebb and flow of the global economy. However, the economic backdrop is of importance as it has a bearing on the appetite for risk and therefore shares.

Global stockmarkets posted a very strong first quarter. A resilient global economy, led by the US, as well as inflation that has continued to fall, created a supportive environment for shares.

This is something of a mixed blessing in that although in March the Federal Reserve (the US central bank) reiterated plans to cut interest rates in 2024, the strength of the economy and the labour market has been sufficient to sow some seeds of doubt around the timing – if not the extent – of the downward move.

Happily, the economic backdrop in the UK has defied the sceptics and naysayers and continued to improve. Inflation has continued to fall, and a recession in the UK, forecast by many, has been avoided. In fact, the ONS (Office for National Statistics) forecasts that UK inflation is likely to fall to the 2% target within months, and the economy (as measured by Gross Domestic Product, or GDP) is predicted to grow by almost 2% in 2025 – not something to write home about, but certainly a welcome improvement on 12 months ago. As a result, the Bank of England may now be able to cut rates and indeed this may happen sooner than in the US.

You will recall that although the domestic economy is of only modest importance to many UK companies (and your portfolio), in the eyes of the international investor the health of the UK economy plays an important role in their thinking and as a result the UK now looks increasingly ‘attractive’ to the global equity manager.

By and large, the management teams of the companies we hold have struck a quietly confident tone in their full-year results, outlooks and meetings with us. In as much as it affects some of our companies, inflationary pressures, particularly with respect to labour, continue to subside. Supply chain conditions continue to improve (Smiths’ finance director suggested that supply chain normality had returned, for example) and most importantly, competitive positions across the portfolio continue to strengthen as weaker industry participants remain under pressure from higher borrowing costs.

Performance

Our fund returned 5.8% over the quarter, beating both the FTSE All-Share index (a widely-used indicator of the performance of the UK stockmarket, in which the fund invests. It acts as a ‘comparator benchmark’ against which the fund’s performance can be compared. Management of the fund is not restricted by this benchmark), which rose 3.6%, and the average fund in the Investment Association’s UK Equity Income sector, which returned 2.5%. (This is the second of two comparator benchmarks against which the fund’s performance can be compared. It is a group of other asset managers’ funds that invest in shares of UK companies. Management of the fund is not restricted by this benchmark.)

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

On the positive side…

Shares in private equity firm 3i enjoyed a strong first quarter, encouraged by Action’s presentation to investors that continued to showcase the company's particular qualities as a discount retailer. Its profit margins are increasing, despite lower prices, and further high single digit/low double-digit sales growth is expected. In addition, management now believe that the total number of stores could reach 7,300 (from a current base of 2,600).

UK banks posted their strongest quarter of performance in some time

In part this may have something to do with the better prognosis for the economy, but more likely it was the realisation that the scale of potential share buybacks and attractive valuations of UK banks were difficult to argue with.

The appointment of Paul Thwaite (whom we saw as a highly credible candidate) as NatWest’s permanent chief executive officer meant that the government’s intention to sell its remaining 33% stake was able to progress. The appointment hopefully signals the end of a tumultuous period for NatWest and kicks off another in which the organisation can focus on delivery and value creation.

Good results from Wolters

Information services company Wolters Kluwer’s full-year results showed many of the characteristics for which we hold the company. An area of focus across our portfolio, but with respect to our data and analytics holdings in particular, (Wolters, LSEG¹ and RELX) is how these companies are applying artificial intelligence (AI) across their various business lines. Last year, Wolters added a range of generative AI-enabled features across its portfolio (it is important to remember that Wolters has been working with large language models and machine-learning techniques for 10 years) and we expect this rollout to gather steam over the coming years.

On the negative side

Smiths Group

Smiths' chief executive Paul Keel announced his departure with immediate effect late in the quarter. Though his destination has not yet been announced, we do know that he has taken a role in the US, his home market. We were of course disappointed to hear this news. We have engaged extensively with him since he joined the business three years ago and believe he has been instrumental in improving processes across the Smiths portfolio. However, he leaves Smiths in a strong position and it remains a high-quality portfolio of businesses that are at the forefront of innovation in their respective industries. Companies in the more economically sensitive areas like industrials are of course subject to the ebbs and flows of the economy over the short term but Smiths should be well supported by these structural factors looking further out into the future. We look forward to meeting with the newly appointed chief executive – a Smiths ‘lifer’ who has been with the company for over three decades – in the coming weeks.

RS Group

RS Group (industrial equipment) reported slightly disappointing results, leading to downgrades to profit forecasts. We are not sure this negativity is warranted, however, given economic activity continues to be robust. Looking to the longer term, we see RS as a structural winner, given a leading digital offering (making it a more obvious AI beneficiary than its competitors) and the opportunity to extend market share in what remains an extremely fragmented industry. We added to the position through this period of weakness.

Spectris

Electronics group Spectris delivered some robust annual results, though the market focused on a slowing trend in sales as the year progressed. Comparisons with 2022’s outstanding growth were always going to be a challenge, but over the longer term we believe Spectris to be well equipped to deliver good sales growth and higher profit margins.

Activity – adding to Barclays and GSK

We added to our position in Barclays, given its announcement of what looks to be a credible plan to re-focus the business and create significant shareholder value over the medium term. This was supported by a strong meeting with management. Like Lloyds and NatWest, Barclays has the potential to generate double-digit shareholder returns through a combination of dividends and share buybacks for several years.

We also topped up our holding in drugs company GSK. Our extensive engagement with the company in recent months suggests the research and development pipeline to be healthier than the market gives it credit for. Furthermore, we think there has been an improvement from a cultural perspective, which logically should support better innovation and outcomes going forward.

We trimmed our Nintendo holding, given some strong share price performance, as well as Indivior. The rapid growth in drugs that suppress cravings and addictive tendencies could present a challenge to Indivior’s business model.

Outlook – signs of overseas interest in the UK market

While the announcement of the plan for a British ISA was a welcome indicator from the government that reinvigorating the UK stockmarket is moving up the list of priorities, it is unlikely, in our view, to play any significant role in lifting UK valuations. The return of international capital is most likely to be the crucial catalyst, and we are seeing mounting evidence that this might be beginning, with global investors continuing to buy and add to positions in a number of UK companies. The likes of LSEG and RELX have attracted overseas capital for some time, but this buying is now broadening out into some of the more ‘value’ oriented parts of the market.

With respect to the companies we own, their competitive positions continue to strengthen, as outlined above. Tesco remains one of the best examples of this, with Morrisons and Asda feeling the burden of heavy debt loads and Lidl’s rapid expansion slowing considerably with the end of cheap borrowing costs. As a result, the quality of spare cash Tesco and other portfolio holdings are delivering grows stronger by the day, and provides a sturdy margin of safety to the portfolio’s income distribution. We must not forget share buybacks either: portfolio companies continue to repurchase significant proportions of their own shares at attractive valuations, pushing up profits and dividends per share as a result.

All in all, therefore, in our view there is tangible evidence that the conditions surrounding the UK equity market are on the up and this is not lost on global investors. Little by little, it looks as though at long last the tried and tested patience of UK investors is being met with some reward, and the substantial valuation gap versus peers is on its way to being recouped.