Artemis Funds (Lux) – US Extended Alpha update

Source for all information: Artemis as at 30 June 2024, unless otherwise stated.

The second quarter of 2024 saw significant market activity, characterized by notable fluctuations and sector rotations. April commenced with a drop in the S&P 500, driven by weaker sectors such as REITs and information technology, while utilities and energy outperformed. This volatility was primarily influenced by revised expectations for US interest rates, geopolitical tensions in the Middle East and persistent inflation concerns. As a result, bond market dynamics shifted, with fewer anticipated rate cuts and some speculation of potential hikes.

In May, the S&P 500 rebounded, largely propelled by the technology and utilities sectors, spurred by lower bond yields and a less volatile geopolitical environment. Notably, Nvidia's stellar results signalled the ongoing AI boom's expansion beyond hyperscalers (large cloud services providers), boosting mid-sized enterprises' AI spending.

June maintained this upward trajectory. However, the market revealed a stark bifurcation: the 'Magnificent Seven' surged, while mid-cap stocks experienced a decline. This divergence highlighted the concentration risk within the market, as large-cap stocks significantly outperformed their smaller counterparts. Overall, the S&P 500 returned 4.3% over the quarter.

Performance Attribution

The fund underperformed the index over the quarter, returning 2.3% vs. the S&P 500's return of 4.3% (in USD terms). Year to date the fund remains comfortably ahead of the index.

Over the quarter we had strong positive contribution on the short side, which was more than offset by the negative contribution on the long side of the portfolio. The short side benefited from weak share prices in a broad range of sectors and industries, including speciality retail, healthcare, and consumer staples.

On the long side, the key themes detracting from performance were weakness in our life sciences, transport, housing, and restaurant exposed holdings, all of which suffered quite sharp selloffs as sentiment towards the expected recovery soured. From a stock perspective the two principal detractors were Avantor and Builders FirstSource. The former was hurt as the expected pick-up in the lifesciences sector was pushed out further. We maintain a position although at a smaller weight. The latter performed strongly over 2023 and has of late given up some performance on weaker housing data that shows there is yet to be a more sustained pickup in housing demand. Our underweight to Apple also proved to be a headwind as the market became less pessimistic about the iPhone producer’s earnings outlook.

On the long side, the key theme contributing positively to performance was AI. This included Nvidia, which benefited from heightening market optimism after another significant earnings beat. Expectations for earnings amongst the analyst community are now in line with our estimates, and in some cases ahead, so we have scaled back our overweight. We are also aware of supply chain constraints, particularly around capacity issues with high bandwidth memory producers which might act as a headwind to Nvidia’s earnings over the next few quarters.

Within a similar theme, we also had a strong contribution from our holdings in Coherent, a business that supplies high speed network cabling and lasers that are an essential component of the current buildout of data centres. Micron, the memory chip producer, also is benefitting from the same buildout.

Changes to the Portfolio

Throughout the quarter, we made several changes to the portfolio. In April, the fund added long positions in a discount retailer, Dollar General, and health insurance company UNH, while exiting positions in Autoliv and American Eagle due to less favourable risk-reward profiles. New shorts were established across sectors such as apparel, auto retail, commercial real estate, and telcos.

In May we bought new long positions in Revvity, Pinterest and Teck Resources, while divesting from Ross Stores, Steris, and TFII. Revvity, a life sciences company, was added for its attractive long-term growth potential despite current depressed fundamentals. Pinterest was chosen for its unique niche in social media advertising, and Teck Resources because of the positive outlook for copper prices driven by expansion of electricity networks.

Later in the period, we bought long positions in Restaurant Brands, Jefferies, Core & Main, and Carnival, and sold positions in Autoliv and American Eagle. Restaurant Brands was highlighted for its resilient franchise model and growth potential, especially under new management with a proven track record.

On the short side, we added new positions in various sectors, including payments, airlines, and technology, targeting companies with high valuations and deteriorating fundamentals. We also reduced position sizes in stocks that performed well, particularly those linked to the AI theme, to maintain an attractive risk/reward profile.

Outlook

Looking ahead, we are keeping a balanced outlook with a net equity exposure of 94%, consisting of 115% long positions and 21% shorts. The long book focuses on themes such as health insurance, life sciences, payments infrastructure, information services, transport, and AI investment beneficiaries, all categorized under our 'discounted compounder' or 'cyclical opportunity' baskets.

On the macroeconomic front, there are signs of increasing economic pressure, with stagnant existing home sales, rising credit card delinquencies, and subdued ISM indices. Despite these headwinds, market volatility remains low, and market concentration is high, warranting cautious optimism.

We are also leveraging the current low market volatility to acquire market protection through put options. This strategic approach aims to safeguard against potential downturns while capitalizing on the long-term growth potential of carefully selected stocks.