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Artemis Institutional UK Special Situations Fund

All data as at 30 December 2016 except where specified
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The fund’s aims

The fund aims to provide long-term capital growth by exploiting special situations. The fund invests principally in UK equities and in companies which are headquartered or have a significant part of their activities in the UK which are quoted on a regulated market outside the UK.

Current prices and yield

As at noon, 30 March 2017
Distribution units147.35p
Accumulation units151.39p
Historic yield (acc units)2.33%
Historic yield (dist units)n/a

Investment information

Ongoing charge (acc units)0.78%
Ongoing charge (dist units)0.78%

Fund manager review

Political forecasters are starting to give economists a good name: their predictions have been woeful. However, economists and strategists still come a close second. Their forecasts of recession immediately after the vote for Brexit - and the collapse of the market after a Trump victory - have also proved, so far, wide of the mark. Equity markets have taken Trump’s win in their stride, focusing on the potential of increased spending on infrastructure and tax cuts. The other side of this equation has been the rise in bond yields. More government spending equates to more inflation. Especially in an economy like the US which is performing well already. We have no greater insight than others into what Trump’s election will mean. The history of US presidents (or, indeed, any politicians) delivering on their promises is not great. An increase in spending on infrastructure was predicted after Obama’s election but did not materialise. And the figures being thrown around appear to us to be fanciful. Tax reforms could be an easier win for the new president and that in itself could prove to be a major boost for the US economy.

the increase in M&A we have been predicting finally seems to be happening

In the fourth quarter of last year, however, the likelihood of delivery on policy did not matter: promises were enough and the investment landscape adjusted accordingly. The main adjustment was the long predicted rise in bond yields. The effect was to drive outperformance of financial stocks and any other cyclically oriented sectors. While we have some exposure to financials (a significant position in Barclays, for example) our zero weighting in the mining sector was painful (as it was for most of the year). It was one of the main reasons we lagged the benchmark, producing a 2.4% return compared to the benchmark’s 3.9%.

The other main culprit for the underperformance was our holding in IG Group. The FCA announced a review of the spread betting industry. The essence of this review is to increase protection for consumers by reducing the leverage they can access through the spread betting industry. The industry has grown rapidly in recent years and a number of more aggressive companies have entered. While we had always felt some review was probable, we expected it would impact the more aggressive operators and improve IG’s competitive. While we believe this will happen in the longer term, the proposals are set to affect the whole industry in the short to medium term. We have reduced our holding, believing money tied up in the sector will be dead money for some time.

Although we had to wait until December for the action to begin, the increase in M&A we have been predicting finally seems to be happening. We have received a bid for E2V, our optics and specialist semi-conductor company. The company was in the midst of change under a new management team but its strong niches in technology were spotted by Teledyne of the US. The price is fair in terms of the medium-term prospects of the business and we are minded to accept. We also received an offer for our recently purchased holding in Sky. We were attracted to Sky by its market position, wide content base and history of innovation. Because investors had increasingly become concerned about the changes in the competitive landscape in television due to new entrants such as Netflix and Amazon, we could buy all this at a discounted valuation. Unsurprisingly, the buyer is Rupert Murdoch's Twenty-First Century Fox, which already owns 40% of the equity. Given the competitive uncertainty, the price is fair. The shares currently sit at a discount to the offer price given some concerns of a competition referral. We believe the risks of this are relatively low and expect the bid to go ahead.

At the smaller end of the scale the fund benefited from the strong performances of Speedy Hire and Spirent. Speedy Hire produced strong results that reflected the positive operational leverage of a recovering plant hire business. It was also heartening to see decent buying from the directors after the results. And Spirent rallied on hopes of a much improved performance in 2017. We retain holdings in both companies.

In terms of transactions, the period was quiet. We took some profits in Melrose following its very strong run during 2016. This was purely a valuation call as we felt a lot of the upside of the recent acquisition of Nortek was already reflected in the Melrose share price. We also sold our position in First Group, a company we had held for too long. The promised turnaround in its UK and US bus operations is forever delayed and we see little to convince us that it will ever happen. We initiated a new holding in Smiths Group (the engineering conglomerate) as its new management appear to be moving swiftly to improve returns at the various businesses under the company’s umbrella.

We do not underestimate the task ahead. Markets are at multi-year highs and the economic and political environments are changing rapidly. We believe there is little upside in the market in general (unsurprising given our comments last year!) but feel value remains on a selective basis.

The political landscape is changing and may change further following various elections in Europe this year. Resulting policy changes will have an impact on growth, inflation and exchange rates and we are sure of volatile conditions as investors respond to changes in the economic landscape. We have already seen the impact in the bond market, though equity investors appear sanguine so far.

The significant change in the economic landscape is the apparent return of inflation. This is most evident in the UK, where a depreciated currency is starting to feed through to rising input prices. As consumers we have had it good for some time, with low prices in food and clothing. This is changing. And combined with a year-on-year rise in oil and power prices we see greater risk of inflation than for some time. We are not talking about 1970s-style inflation. But it is a move away from the deflationary environment we have been living in for the past few years. And the UK is not alone. In the US, where the unemployment rate is low and expansionary policies are being mooted, there are also significant risks of rising wages and pricing. Without being alarmist, we need to recognise that risk.

On the subject of obstacles we must mention Brexit but won’t dwell on it. This is not because we don’t think it is an issue - quite the contrary. But we don’t know the outcome or its timing and nor do the companies we talk to. So while speculation about the outcome will have an impact on markets, it is not interfering with our investment process at the moment.

Market valuations are more of an issue. Equity markets have risen steadily since March 2009. Equity multiples have risen faster than earnings and the market overall is now trading at multiples above the long-term average. That in itself is not such an issue as markets can trade at elevated levels for prolonged periods. But it does introduce a greater element of risk and will result in lower returns going forward. Clearly, interest rates at zero have been helpful for equity valuations and rising interest rates should have some impact. However, even as interest rates rise, they will still remain extremely low by historic standards. This is a function of the still high levels of personal, corporate and public debt in the system. So we believe this environment, while not offering much upside, does not necessarily significantly undermine equity valuations.

Our task remains the same. We continue to look for the companies which can prosper in this complicated macroeconomic environment. As ever investors have given up on certain stocks and this offers us our potential target list. 2016 was a tough year for companies such as BT, Capita, Cobham, International Consolidated Airline Group and Restaurant Group. These are examples of the companies on our watch list. All have been de-rated over the past year and may now offer upside greater than the wider market has to offer.

04 November 2016

Derek Stuart: We buy stocks, not the market …

Although economic risks are rising, the UK market has been too. Although overall valuations are looking stretched, this conceals considerable opportunities, according to Artemis’ Derek Stuart.

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Derek Stuart: We buy stocks, not the market …

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