Liontrust Special Situations – fund update

This UK fund has a focus on good-quality, though slightly more expensive, businesses with hard-to-replicate assets.

| 5 min read

Liontrust Special Situations Fund has been something of a stalwart of the Direct Investment Service Preferred List our curated list of investments for new investment in their respective sectors, having been a constituent since 2013. Despite a growing fund size, which has necessitated using fewer smaller company holdings than it has at times in the past, we continue to have conviction in the robust and consistent process applied by the fund’s managers.

Philosophy and process

Anthony Cross has been at the helm since launch in 2005 with co-manager Julian Fosh joining in 2008. The mangers have had the same investment philosophy throughout: to identify companies with long-lasting advantages that allow them to defy competition and drive a higher level of profitability than expected.

Rather than overly obsessing about valuation, the key to the managers’ philosophy is finding the right type of businesses and sticking with them for the long term. The managers believe that the companies most likely to succeed over the long term tend to possess certain strengths, which competitors find hard to replicate.

Most notably they look for the ownership of intellectual property (IP) - intangible assets such as strong brands, copyrights or patents - as well as strong distribution channels or recurring revenues that allow continual reinvestment and development to maintain an edge. These are characteristics that can help keep competitors at bay, allow greater control over pricing (or ‘pricing power’) and potentially deliver superior profit growth over the longer term. They test their thesis about businesses by comparing their cost of capital with their return on capital, ensuring as best they can that the latter is consistently more than the former.

The consistent application of this approach has led to some strong long-term returns, though past performance is not a guide to the future. The fund has also been relatively resilient amidst recent turbulent markets. Like all funds in the sector it was caught up in the market volatility last year but owing to its focus on good-quality businesses with hard-to-replicate assets investors were partially shielded.

Portfolio update

While suffering a small negative return over 2020, the fund displayed some resilience amid the heavy sell-off in the UK market in the first quarter and subsequently harnessed the recovery over the summer too. As such, it significantly outperformed the wider market with the FTSE All Share falling over 10% over the year.

The only significant period of underperformance over the period came towards the end of the year amid the ‘vaccine’ rally from November. At this point many hard-hit areas rebounded very strongly and the fund’s positions in industrials such as Spirax Sarco and Rotork helped it keep up.

The fund’s focus on quality, including attention to a company’s financial position, stood it good stead during a turbulent year. Only one holding, Compass Group, was forced to raise money to shore up its balance sheet through selling more shares. The catering giant was in the eye of the Covid storm, but other fundraisings from portfolio holdings were aimed at raising ‘warchests’ to expand their businesses or make acquisitions – likely an encouraging sign for future earnings.

Some of fund’s the 2020 outperformance can be attributed to low exposure to the worst hit areas, notably financials where the fund has no banks or insurers. The fund also had little exposure to retail and leisure. Meanwhile, exposure to software firms was helpful, and the strongest stock-specific contributions to performance included GlobalData, Domino’s Pizza Group, AstraZeneca, YouGov and TP ICAP.

The biggest group of recent detractors in the portfolio can be attributed to oil price weakness. A combination of reduced global demand during lockdowns and limited oil storage space amid a supply glut led oil prices to tumble. The Fund’s holdings in BP, Shell, John Wood Group, Plexus Holdings and Weir Group all suffered heavy share price falls. However, the damage was limited. Oil & Gas was, overall, an underweight sector versus the market during the start of the 2020 before the managers moved to a neutral position once the sector was depressed and they believe it still offers value.

The numbers of holdings in the portfolio has crept up, notably so in the smaller company space where the managers find it harder to build meaningful positions than they have historically. It continues to offer a well-rounded portfolio offering exposure to a wide range of UK companies. Smaller companies and those listed on AIM (Alternative Investment Market) currently account for a quarter of the fund, with FTSE 100 constituents accounting for 38% and the mid-cap FTSE 250 31%. The balance of 6% is in cash.

Our view

This fund represents a concentrated ‘best ideas’ portfolio managed by a highly impressive team with a consistent and disciplined process. The slight fly in the ointment is that success has brought popularity and a large fund size. Over time this has forced the fund to migrate progressively towards larger companies as it has become harder to secure positions in meaningful proportion in many smaller. With a shallower pool to fish in we think future outperformance will be harder won, although so far it hasn’t dented returns which we believe is testament to the skill of the managers.

Nothing on this website should be construed as personal advice based on your circumstances. No news or research item is a personal recommendation to deal.

Liontrust Special Situations – fund update

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