Artemis Institutional UK Special Situations Fund Manager s Short Report Investment objective and policy The investment objective of the fund is 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. The securities of companies listed, quoted and/or traded in the UK but domiciled elsewhere and the securities of companies traded on ISDX may be included in the portfolio. Income within the portfolio is accumulated and reinvested. The fund aims to provide investors with a total return in excess of that of the FTSE All-Share Index. The manager actively manages the portfolio in order to achieve this objective. Exposure to large, medium and small companies varies over time, reflecting the manager s views on where the greatest performance potential exists. The fund may also invest the property in transferable securities, money market instruments, derivatives and forward transactions (for the purposes of efficient portfolio management), deposits and units in collective investment schemes. Risk profile In pursuing the investment objective the fund holds a number of financial instruments. The main risks arising from the fund s financial instruments are: Market price risk The potential loss the fund might suffer through holding market positions. Investors are reminded that past performance is not a guarantee of performance in the future and that the price of units and the revenue from them can fall as well as rise. Fund information Launch date 16 March 2005 Unit type Accumulation Historic yield + 2.2% Accounting dates 30 June & 31 December Distribution date 28 February + The historic yield reflects distributions declared over the past 12 months as a percentage of the mid-market unit price, as at the date of this report. It does not include any preliminary charge and unitholders may be subject to tax on their distributions. Report & accounts This document is the Short Report of the Artemis Institutional UK Special Situations Fund for the year ended 31 December 2015. The Manager s Report and Financial Statements can be obtained from the manager s website artemis.co.uk, by contacting Elaine Gordon on 020 7399 6217 or by writing to the manager s address below. For the year ended 31 December 2015 Manager and Alternative Investment Fund Manager ( AIFM ) Artemis Fund Managers Limited * Cassini House 57 St James s Street London SW1A 1LD Dealing information: Artemis Fund Managers Limited PO Box 9688 Chelmsford CM99 2AE Telephone: 0800 092 2051 Website: artemis.co.uk Investment adviser Artemis Investment Management LLP * Cassini House 57 St James s Street London SW1A 1LD Trustee and Depositary National Westminster Bank Plc Trustee & Depositary Services Younger Building 1st Floor, 3 Redheughs Avenue Edinburgh EH12 9RH Registrar International Financial Data Services (UK) Limited * IFDS House St Nicholas Lane Basildon Essex SS15 5FS Auditor Ernst & Young LLP Ten George Street Edinburgh EH2 2DZ * Authorised and regulated by the Financial Conduct Authority ( FCA ), 25 The North Colonnade, Canary Wharf, London E14 5HS. Authorised by the Prudential Regulation Authority ( PRA ), 20 Moorgate, London EC2R 6DA and regulated by the PRA and the FCA. 1
Artemis Institutional UK Special Situations Fund Manager s Short Report Investment review Performance To complete a Tough Mudder endurance event, participants must negotiate a long obstacle course: climbing up, jumping down, wading through mud and crawling under electrified wires. The potential for self-harm is significant. We have not taken part in one of these events but after 2015 we feel we have some experience of what it must be like. Markets first moved one way, then the other. All the while they scattered various obstacles in the path of investors. Indeed, this year s selection of stumbling blocks Greece, the UK general election, China, a collapse in commodity prices, terrorism and central bankers make the prospect of a Tough Mudder seem appealing. That the fund s benchmark produced a positive return (albeit of just 1.0%*) is quite amazing. As to whether this was an act of resilience or denial? Take your pick. The fund managed to do much better than the market, producing a return of 6.2%* for the year, though it did sometimes feel as though we were wading through mud. Review How did the fund manage to emerge from 2015 s obstacle course in such good shape? First, having minimal exposure to the mining and oil sectors was a major help. We looked at commodity prices at various times during the year and wondered if they had reached the bottom and on each occasion the answer was no. It remains incredibly difficult to establish what the price of commodities ought to be and what the underlying cashflows of companies in these sectors are. For the moment, we remain on the sidelines while recognising that the speed at which prices have fallen may present opportunities sooner rather than later. Indeed, for many companies with debt the time of reckoning is approaching. Banks, who have thus far been happy to extend covenants, are now looking to other solutions. The resulting refinancing may present us with some lucrative investment opportunities. Of more interest to us, and hopefully to you, are the stocks which produced real value for the fund. Our software holdings were strong performers again, with Micro Focus International and Computacenter delivering good returns. Micro Focus International continues to perform well following its acquisition of Attachmate. Its strategy of driving down costs while investing in its sales effort has already produced results that are ahead of our expectations. This growth in profits is being accompanied by strong cashflows, allowing debt to be repaid ahead of schedule. With the Attachmate deal the company inherited SUSE, an enterprise software business that uses the opensource Linux operating system. Unlike the rest of Micro Focus International s businesses, which are typically lowgrowth but high-margin operations, SUSE is growing its top line at 15% while still enjoying margins in the mid- 30% range. The value of this business is yet to be fully reflected in the valuation the market is awarding to the whole. Meanwhile, Computacenter s share price continued to trundle higher as it improved the quality of its earnings and as the revenues from contracted services increased. Both companies have performed well but their valuations are still attractive so they remain sizeable holdings. Investments in gaming and leisure remained a prominent feature of the fund. Our holding in Rank Group has enjoyed a significant re-rating thanks not only to improved trading at its casino and bingo venues but also in response to the strong growth in its online offering. Rank Group was somewhat behind the rest of the gaming sector in developing this part of its business so, in part, this growth represents a catching up. And it is only natural for such a strong, established brand to see some cross-selling opportunities emerging between its businesses. The re-rating of Rank Group s shares, meanwhile, provided some consolation for our experience with Betfair Group. We held it for two-and-a-half years, enjoying a rerating in its shares in that time. Sadly, we sold before a merger with Paddy Power pushed them even higher. We acknowledge the old saying that we must be prepared to leave some upside for the next investor but we are not a registered charity and would have preferred to keep it for our unitholders. The fund also benefited from a pick-up in corporate activity. We had expected this for some time. As noted in this year s interim report we received a bid for Pace. That deal completed at the end of 2015. And, much to our relief, we also received a bid for Xchanging. We had run into some difficulties with this investment: we could see value but were unsure how it would be crystallised. The initial bid came from Capita. But that was followed by three rival offers. In the end, Computer Sciences offer of 190 pence-pershare seems to have won the day. This compares to a share price of just 93 pence before the bidding started. Elsewhere, Honeywell bid for Melrose s utility meter business, which the latter bought in 2012. The sale value equates to a return of 2.3 times the equity investment and leaves Melrose s management free to focus on the next deal. This surge in takeover activity carried over into 2016 with news of Sainsbury s approach for Home Retail Group, another of last year s problem stocks. Slowing growth at Argos had disappointed investors and it increased spending on marketing ahead of the all-important Christmas period. Our premise for investing in Home Retail Group rested on its low valuation, the rationalising of Homebase and the reinvigoration of Argos. And, while there has been good progress at Homebase, the jury remains out on Argos. That said, Sainsbury s clearly sees value in it. Investors have become increasingly wary of any business where there is a whiff of structural challenge. In sectors such as retail and media, business plans are being torn up as the digital * Source: Artemis/Lipper Limited, mid to mid basis, in sterling with net income reinvested, gross of fees. Benchmark is the FTSE All-Share Index. 2
age heralded back in 2000 finally arrives. As investors in turnaround opportunities we will need to tread very carefully here, avoiding structural challenges that are too severe even for the most talented of management teams. In this, Home Retail Group has been an interesting lesson. Another problem child was Morgan Advance Materials ( MAM ), badly affected by the sharp downturn in the global economy at the end of the summer. Management is cutting costs and, to an extent, this will help profits. Of more interest is the new chief executive. He takes over a company that has interesting technologies but lacks focus. In the short-term, trading could remain tough. But we believe he will address MAM s problems and create long-term value for its shareholders. Outlook As 2016 begins, another Tough Mudder challenge seems to await. The obstacles are somewhat familiar, albeit that the UK s general election has been replaced by the prospect of an EU referendum (after the Scottish referendum in 2014 and the EU referendum in 2016 might there be some sort of global referendum to enjoy in 2018)? Investors must also be prepared for volatility and slower growth in emerging markets. To some degree this is the consequence of experiments in quantitative easing across the West. And while it is extremely tedious for us to write (and must be even worse for you to read) we reiterate that we are in a period of very low growth which is a result of high levels of debt. None of the real economic issues have been dealt with and investors must fend for themselves as central bankers try to step away from manipulating markets. But there is some good news. First, given the weak state of the world economy it is unlikely that interest rates will rise rapidly. So investors will still need to look beyond cash for a return. Second, as managers of a special situations fund, we have spent years fending for ourselves, identifying companies with the potential to deliver returns through their own efforts rather than relying on the wider economy. If identifying self-help situations was important when we launched this strategy in 2000, it is even more so today. So if you are hoping for a decent return from the equity market as a whole this year then you are likely to be disappointed. That is not to say there is no value rather that it is to be found in isolated pockets. The significant decline in the oil price should offer us some interesting ideas. We expect to increase our weighting in oil stocks as the year progresses. That the decline in the price of oil has hurt power companies also offers opportunity. So our list of ideas is building nicely but we are being patient before buying. We feel the earnings of some of our potential investments still have the scope to disappoint. Meanwhile, corporate activity is likely to remain a feature of markets. Companies are desperate to generate growth and buying another company is one simple way to do it. So, although we start 2016 seeing opportunities, a selective approach will be more important than ever. Derek Stuart & Andy Gray Fund managers 3
Artemis Institutional UK Special Situations Fund Manager s Short Report Investment information Portfolio split 31 December 2015 % of net assets 31 December 2014 % of net assets Consumer Services 20.06 17.42 Industrials 17.83 14.87 Technology 14.82 13.35 Financials 13.92 26.62 Healthcare 9.65 3.62 Oil & Gas 6.35 11.07 Telecommunications 5.88 6.26 Consumer Goods 2.58 0.37 Utilities 1.51 2.04 Basic Materials 1.23 2.34 Net other assets 6.17 2.04 Net assets 100.00 100.00 Ten largest investments Investment 31 December 2015 % of net assets Micro Focus International Plc 4.52 GlaxoSmithKline Plc 3.80 Barclays Plc 3.42 Computacenter Plc 3.30 AstraZeneca Plc 3.19 HSBC Holdings Plc 2.99 BP Plc 2.80 Smith & Nephew Plc 2.66 Pace Plc 2.63 Vodafone Group Plc 2.63 Investment 31 December 2014 % of net assets Micro Focus International Plc 4.81 BP Plc 3.95 Royal Dutch Shell Plc B shares 3.63 HSBC Holdings Plc 3.35 Jelf Group Plc 3.31 Friends Life Group Ltd. 3.27 Phoenix Group Holdings 3.10 Barclays Plc 2.94 RELX Plc 2.75 Mitchells & Butlers Plc 2.74 4
Comparative tables Accumulation 2015 2014 2013 Change in net assets per unit (p) Opening net asset value per unit 128.96 124.68 94.49 Return before operating charges * 8.48 5.27 31.06 Operating charges (1.04) (0.99) (0.87) Return after operating charges 7.44 4.28 30.19 Closing net asset value per unit 136.40 128.96 124.68 Retained distributions on accumulation unit (3.03) (2.21) (2.72) * after direct transaction costs of (0.46) (0.31) (0.33) Performance Return after charges 5.77% 3.43% 31.95% Other information Closing net assets ( 000) 126,094 135,346 143,845 Closing number of units 92,445,894 104,948,245 115,372,078 Operating charges 0.78% 0.78% 0.78% Direct transaction costs 0.34% 0.24% 0.30% Prices Highest unit price (p) 138.12 131.60 124.90 Lowest unit price (p) 127.93 118.07 96.84 Direct transaction costs are stated after deducting the amounts collected from dilution adjustments in relation to direct transaction costs added to issues of units and subtracted from the cancellations of units. Distribution table Payment date Accumulation (p) 27 February 2015 2.7234 26 February 2016 2.2054 Ongoing charges Class 31 December 2015 Accumulation 0.78% Ongoing charges shows the annual operating expenses of each unit class as a percentage of the average net assets of that class for the preceding 12 months. Fund performance Artemis Institutional UK Special Situations Fund (gross of fees) Artemis Institutional UK Special Situations Fund (net of fees) FTSE All-Share Index (gross of fees) Since launch* 5 years 3 years 1 year 6 months 195.8 64.5 47.1 6.2 1.3 173.1 58.5 43.9 5.4 1.0 101.7 33.8 23.4 1.0 (2.0) * Data from 16 March 2005. Source: Artemis/Lipper Limited, mid to mid basis, in sterling with net income reinvested to 31 December 2015. All performance figures show total return percentage growth. 5
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