01 Jul 2019
Although investors – and the Fed – may be worried about slower growth, there are still clear areas of strength in the US economy. Cormac Weldon explains how the Artemis US Smaller Companies Fund exploits them.
Although we are late in the economic cycle, we don’t think a recession is imminent. President Trump’s stance on global trade is starting to affect business confidence, leading to a slight slowdown in capital expenditure. But the US consumer is in good health, employment is very strong, wages are rising (particularly among lower earners) and levels of personal debt are manageable. As a result, we expect the economy to continue to expand. At the same time, inflation remains subdued and the market has moved from expecting the Fed to raise rates this year to expecting it to cut.
With its highly developed venture capital market, America is home to some of the world’s most innovative and fastest growing companies. The US smaller companies market is larger and deeper than many investors realise. Many ‘small’ companies in the US are not particularly small – the Russell 2000 index (the benchmark for the smaller companies market) includes stocks with a market cap of up to $10 billion. One point of difference is that while the large companies that populate the S&P 500 index tend to be global businesses, smaller companies are much more likely to have a domestic focus. By owning them, investors can therefore benefit more directly from the dynamism of the largest economy in the world.
There are, of course, risks to investing in smaller companies: they are less widely traded, receive less scrutiny from analysts and their share prices can be more volatile than their larger peers. At the same time, because they receive less attention from analysts we believe that there are more opportunities for stockpickers to identify overlooked or mispriced gems.
As we are coming to the end of the economic cycle, we look for firms with low debt and the ability to grow their earnings autonomously (or at least keep them stable). So our fund has a bias to higher-quality stocks, which has meant that during periods in which the market has weakened the fund has not fallen as far as the smaller companies’ index.
Although we do own some loss-making companies, our focus is very much on businesses with new products that we believe will help make them profitable in the foreseeable (rather than distant) future. We take pains to avoid companies whose lack of scale, lack of innovation or lack of access to capital might make them ‘value traps’ (a stock that appears ‘temporarily’ cheap or undervalued at first glance but whose ability to make profits has, it transpires, been permanently and severely impaired).
Given the current financial strength and spending power of US consumers, the fund has a significant level of exposure to a broad range of consumer-related companies. One example is an affordable gym chain offering basic equipment to less enthusiastic gym goers at a lower fee than other chains. Another is a retailer that sells products for five dollars or less to teen and pre-teen customers. A more recent addition is a company that distributes the chemicals and parts used to maintain residential swimming pools. Its customers are the contractors that homeowners use to maintain their pools. And because these contractors are not spending their own money on these products (they simply bill the pool owner), they are relatively insensitive to increases in prices.
The fund is very underweight banks. Every year the larger banks invest heavily in technology. Smaller regional banks cannot compete with this and are likely to suffer as a result, so we tend to avoid them.
The most frequently cited benchmark for the performance of smaller companies is the Russell 2000 index. When its returns are compared with the S&P 500, it can look like smaller companies have struggled to outperform their larger peers. But we think the Russell 2000 is actually a fairly poor gauge of how smaller companies perform. As a benchmark, it has some structural flaws that an active investor may be able to avoid. A significant amount (over 30%) of the companies within the Russell 2000 index are loss-making. And many of the companies in the index are heavily indebted.
We think the returns our fund has produced illustrate what can be achieved through an active approach to investing in smaller companies. Over the past three years, the S&P 500 has outperformed the Russell 2000 index, but the Artemis US Smaller Companies Fund – with its bias towards profitable, high-quality businesses – has significantly outperformed both.
Please remember that past performance is not a guide to the future. Source: Lipper Limited, class I GBP accumulation units, mid to mid in sterling to 31 May 2019. Since launch data from 27 October 2014. All figures show total returns with dividends reinvested, net of ongoing charges and portfolio costs. As the class was launched less than five years ago, complete five-year performance data is not yet available.
To find out more about the Artemis US Smaller Companies Fund and its positioning visit the fund page at www.artemisfunds.com.
THIS INFORMATION IS FOR INVESTMENT PROFESSIONALS ONLY. IT IS NOT FOR USE WITH OR BY PRIVATE INVESTORS.
The fund is an authorised unit trust scheme. For further information, visit www.artemisfunds.com/unittrusts. Third parties (including FTSE and Morningstar) whose data may be included in this document do not accept any liability for errors or omissions. For information, visit www.artemisfunds.com/third-party-data. Any research and analysis in this communication has been obtained by Artemis for its own use. Although this communication is based on sources of information that Artemis believes to be reliable, no guarantee is given as to its accuracy or completeness. Any forward-looking statements are based on Artemis’ current expectations and projections and are subject to change without notice.
Issued by Artemis Fund Managers Ltd which is authorised and regulated by the Financial Conduct Authority.