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A deeper look at SharingAlpha favourite Liontrust’s UK Smaller Companies fund

David Stevenson, 11/02/2021

Looking at the funds voted by SharingAlpha’s elite group of selectors, some may be surprised to see any UK-focused products in there. At all. However, the FTSE 100 has the dubious honour of being one of the world’s major indices that didn’t finish 2020 up, compared to the more tech-oriented US S&P 500 for instance. Looking down the market cap spectrum may show why fund professionals selected Liontrust’s UK Smaller Companies fund.

Fundeye spoke to Victoria Stevens and Matt Tonge, managers of the fund and the first thing to notice is the focus on quality stocks, often with a tech bias. This was not a reaction to the calamity of Covid-19 as stocks such as IMImobile and YouGov had been in the portfolio for some time.

The pair are also part of the management of the firm’s microcap fund, a product that came after the Smaller Companies fund but follows a similar stock selection process. Apparently, there is a 30 percent crossover between the two funds with companies that become too big having to exit the microcap fund although Smaller Companies gives the team greater leeway to let companies grow.

What are the team looking for when selecting stocks for what is currently a 68 holding portfolio? Ms Stevens said that the key attributes are intangible assets strength within businesses with recurring income. This naturally gives software or SaaS (software as a service) companies an edge when it comes to falling into their radar. However, conversely, travel, retail and leisure stocks don’t tend to have much patented IP and given the events of last year it’s fortunate these sectors are shunned by their stock filtering process.

Another area favoured by the team is investment platforms and wealth managers from Brooks MacDonald, to Integra and Nucleus, with the latter enjoying an M&A premium from the recent news that James Hay Group is taking the company private. Its share price jumped 11 percent on this week's news.

“Fortunately for us, they [SaaS and investment platforms] happened to be areas of the market where the impacts of the pandemic and the lockdown were relatively speaking quite muted,” said Ms Stevens, whereas other fund managers with a similar market cap focus entered into the pandemic holding stocks such as bowling company Hollywood Bowl and Cineworld which were of course decimated.

Get what you pay for

Describing the general nature of the companies that the team likes, Matt Tonge said they tend to be high quality as a style, versus say value type stocks. These type of stocks tend to be more expensive as ‘people tend to want to put their money into high quality’ according to Mr Tonge. So compared to the fund’s index, the FTSE Small Cap, the fund may be considered expensive but then again on a yearly basis the fund has returned almost double what the index has. Therefore using the old adage, you get what you pay for.

Another strict requirement the managers have is that companies have to have a minimum of 3 percent ownership by management. In fact, across the portfolio this is more like 20 percent and ensures that the interests of shareholders are aligned with management. As Ms Stevens points out, this makes management more risk adverse and less likely to engage in risky M&A activity which can be ruinous if there are cultural issues or other problems. It may also make them less likely to over leverage themselves which given current market conditions, excessive debt is perhaps not prudent.

The fund’s top holding IMImobile has been a tremendous success, perhaps shown by another holder of the stock, Gresham House Strategic taking profit from it by selling 40 percent of its holding back in 2018.

Liontrust seems to ride its winners, the fund has taken between 10-15 companies from its microcap product when they’ve grown too large and put them in Smaller Companies. This epitomises the growth style of the fund and a style which while many suggest the market may rotate into value seems alive and well in this fund.

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