Fund Spotlight: a rare opportunity to own US growth at a bargain price

The much-anticipated US recession in 2023 never happened and investors in the US market will be rather pleased with the 19.2% return they achieved from the S&P 500 index over the calendar year.

While still achieving a return of 10.3% in 2023, the Russell 2000 index, which is made up of smaller businesses in the US, underperformed its large-cap counterpart. This was in part due to fears that slowing economic growth would disproportionately affect smaller companies which tend to generate most of their revenue domestically and are more sensitive to the economic picture in the US.

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Looking ahead, risks continue to be on the table for investors in the US. However, improving inflation conditions, labour market softening and interest rate cuts are all factors which have the potential to boost the outlook for US smaller companies in 2024. Valuations of US small-caps versus large caps are now historically cheap. The price to earnings (P/E) ratio of the Russell 2000 is near to 14 and below the 10-year average of 17.8. In comparison the P/E of the S&P 500 is just below 24 and above its 10-year average of 21. This presents an opportunity to buy shares in profitable and fast-growing companies at modest valuations.   

The Artemis US Smaller Companies fund is a “best ideas” portfolio managed by Cormac Weldon and Olivia Micklem. Its objective is to grow capital over a five-year period. The portfolio holds between 50 and 70 shares whose stock market values are mostly below $10 billion (£7.9 billion). While the fund is focused on a relatively select list of companies, these are found across a breadth of sectors. This diversification can help to mitigate the typically elevated share price volatility of small and mid-caps.

What does the fund invest in?

Weldon and Micklem pick shares from a pool of more than 2,000 small and mid-sized US companies. America is home to a huge number of the world's most innovative, entrepreneurial and fastest-growing small companies. America’s “smaller” companies are large by British standards, with around half the FTSE 100 index having a market cap of less than $10 billion. In most cases the managers will mostly invest only in companies which are profitable, with just 2% of the portfolio currently invested in loss-making companies. Of that 2%, all should be profitable within the next 12 months. All companies held are perceived to possess a competitive advantage in the form of innovation or benefiting from greater scale than peers.

The strategy utilises a bottom-up stock selection process while keeping a close eye on the wider macro environment and is fairly benchmark agnostic – with performance measured against the Russell 2000 index. Management has a flexible mandate and are valuation conscious, however the fund tends to hold larger, more growth-oriented companies compared to its peers. The fund is well overweight mid-caps versus the index and peers.

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The portfolio has an overweight versus the index to industrials by (17%), consumer defensives (8%) and basic materials (6%) relative to the index. The sectors with lower exposure compared to the index are healthcare (-8%), consumer cyclicals (-6%) and financial services (-7%). The resulting portfolio is composed of 53 holdings and is quite concentrated, with 38% of the portfolio's assets housed within the top 10 holdings.

One of the highest conviction holdings is Constellation Energy (NASDAQ:CEG) which generates and supplies clean energy across the US. Its earnings are being driven higher by its reliability as a supplier and its customers willingness to pay more due to the volatility in energy prices. The company is also an indirect beneficiary of breakthroughs in artificial intelligence, as energy-intensive data centres are being built in the States that Constellation serves. This stock has returned 41.5% over 12 months.

Saia Inc (NASDAQ:SAIA) is another holding which features in the fund’s top 10. It is a transportation company for relatively small loads or quantities of freight or “less-than-truckload”. The portfolio managers believe the outlook for these companies are more positive than general trucking. In the summer a former top five carrier Yellow Corp filed for bankruptcy providing SAIA the opportunity to pick up further market share. SAIA has returned 93.4% over the past 12 months.

How has the fund performed?

Despite underperforming peers during the recent tough environment for smaller companies in 2022, long-term investors should be encouraged by the annualised return of 13.6% this achieved since inception in 2014, which outpaces the Russell 2000 index by 4.1 percentage points annually. The risk-adjusted performance only continues to make a case for this fund. The fund led the index with a higher Sharpe ratio, a measure of risk-adjusted return, over the trailing five-year period. This strategy also had more consistent returns, as denoted by a lower standard deviation of 23.1% compared to 24.8% for the benchmark.

During the latter months of 2023, outperformance versus the index has been driven by stock selection across the industrials, consumer discretionary and healthcare sectors. The top stock contributors have been TopBuild Corp (NYSE:BLD), Natera Inc (NASDAQ:NTRA) and e.l.f. Beauty Inc (NYSE:ELF), which all rallied into the year end.

Source: Morningstar Total Returns (GBP) to 31/12/23. Past performance is not a guide to future performance.

Given the current market outlook, this year Weldon and Micklem are seeking opportunities to own businesses that have already had their profits suffer and have strong enough fundamentals to weather the storm. Two current areas of interest are life sciences and trucking companies, which struggled in 2023. They will be looking out for signs that the downtrend in orders for life sciences companies is bottoming out and for evidence of improving profitability of trucking companies.

Why do we recommend this fund?

Overall, this fund presents a compelling option for investors looking to add an adventurous element to their portfolio and gain exposure to US Smaller companies, which are often more entrepreneurial businesses than larger peers. The fund is a member of the ii Super 60 list.

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The current outlook for the US warrants investors to take a closer look at the small-cap space. Choosing an actively managed fund allows investors to avoid the large proportion of the index that is consistently profitless. With an ongoing charges figure (OCF) of 0.87%, this remains a competitively priced option with strong track record.

While investing in smaller companies exposes investors to heightened volatility of returns and the potential for liquidity risk, the portfolio management team’s expertise in this space gives investors with a five-year time horizon a suitable vehicle to access this area of the market.

Please find the live factsheet here.