Liontrust Special Situations – fund update

This UK fund has held up reasonably well amidst recent turbulent markets owing to its focus on good-quality businesses with hard-to-replicate assets.

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  1. Rob Morgan

Liontrust Special Situations Fund has been something of a stalwart of the Foundation Fundlist, our list of preferred funds across the major sectors for new investment, having been a constituent since 2013. Despite a growing fund size, which has necessitated using fewer smaller company holdings than 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 widely 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, which 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 habitually 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 volatility, but owing to its focus on good-quality businesses with hard-to-replicate assets investors were partially shielded.

Portfolio update

According to Mr Cross, near term operations and returns from many of the companies in the portfolio will undoubtedly be tested during the ongoing Covid-19 crisis, but due to the quality of the businesses they should generally emerge in a strong position. Where businesses need support through issuing bonds or more shares, he believes investors will be happy to meet this, and in certain cases if share prices do languish, he expects merger or acquisition activity could ultimately buoy them. This has certainly been a key theme for the fund in the past. Various holdings have, from time to time, been the target of a trade buyer with a more optimistic view of value than ascribed by the market.

A look at the fund from a sector level also reveals why it has been relatively well insulated from the pandemic fallout. Some of the most acutely affected areas are entirely absent, including retail banks, property companies, mining, transport and pubs. There is also little exposure to retail, travel and leisure stocks. In contrast, the fund holds significant positions in less affected areas such as IT software and healthcare, the latter through both GlaxoSmithKline and AstraZeneca. Meanwhile, consumer stocks such as Diageo and Reckitt Benckiser have performed well amidst strong demand for beverages and household products, and engineering firms such as Renishaw and Spirax-Sarco have rebounded strongly from March lows.

Among the more troubled areas held by the fund are oil majors BP and Shell – albeit the positions are at lower weights than the overall market – and catering giant Compass, which has been adversely affected by the hiatus in hospitality and travel. Mr Cross is still happy with the quality of the business but chose not to partake in the recent rights issue where the company raised money to help see it through the crisis via the sale of more shares. In his view, the pace of the economic recovery from the pandemic is still too uncertain to give him enough confidence to add to his now-diminished stake.  Recruitment companies Page Group and Robert Walters also face a downturn, though Mr Cross is satisfied they are in a good position to whether the storm and emerge stronger as they have significant cash piles and staff have transitioned well to working from home.

Cash in the fund is relatively high presently at around 10%. This is to allow a buffer in case of large withdrawals (albeit the fund has seen net inflows overall during the past few months) and to allow the fund to readily partake in any fundraisings for existing holdings if they occur and if desired. Cash is normally kept in the region of 5-7%, which allows the fund to more comfortably invest 20-30% in smaller companies, which tend to be less ‘liquid’ – i.e. they are harder to buy and sell in quantity.

Our view

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

Past performance is not a reliable guide to future returns. This website is not personal advice based on your circumstances. No news or research item is a personal recommendation to deal. Investment decisions in fund and other collective investments should only be made after reading the Key Investor Information Document or Key Information Document, Supplementary Information Document and Prospectus. If you are unsure of the suitability of your investment please seek professional advice.

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