2024 was another year in which investment approaches aligned with a quality, growth style faced challenges in the form of the dominance of value-style equities, particularly among large-caps. Illustrating the scale of this headwind, the MSCI UK Large Cap Value Index delivered a 15.0% total return, ahead of the broader all-cap FTSE All-Share Index return of 9.5%.
This environment was particularly tough for the junior AIM market, which was affected by both its growth orientation and political uncertainty around tax reliefs ahead of the Autumn Budget.
We saw a similar environment in 2022, as the emergence from covid lockdowns saw economies globally experience a spike in inflation, necessitating higher interest rates.
Company financials remain strong and in line with long-term averages
As long-term investors, we have confidence that these style headwinds are temporary and must abate, and we retain our long-held high conviction that companies with high quality characteristics are the most likely to compound growth and deliver attractive returns to shareholders over a period of several years.
The good news is that, looking at our companies’ financial performance, their quality hallmarks are still strongly in evidence – running broadly in line with long-term averages across most measures.
Taking the Liontrust Special Situations Fund as an example, the weighted average cash flow return on capital of the portfolio is 14.6%, more than twice the UK market average. A free cash flow yield of 8% is particularly compelling and is at levels not seen for a very long time in the Fund’s history. The portfolio’s operating margins are 60% higher than the UK market average, while balance sheet solvency is also a key strength: net debt-to-EBITDA leverage for the portfolio is less than half that of the wider market.
Valuations have slipped to very compelling levels
It is valuations, not fundamentals, which have weakened.
Again, looking at the Special Situations portfolio, nearly 90% of the stocks are trading at a discount to their long run average valuation, with an overall average price/earnings ratio of 13x, a discount of around 20% to the long-term average of 16x.
These companies’ short-term growth prospects are healthy and offer no reason to justify such a sharp valuation discount. Based on market consensus (as at the end of December) the portfolio is expected to deliver around 7% earnings growth for the year ahead. Whilst this is modestly
below the long run average, in the context of an uncertain macro backdrop we feel it is attractive and represents further recovery potential as cyclical headwinds subside.
When you add in an expected dividend yield which is now around 3%, this should offer significant support to valuations next year.
Across our range of UK funds, it is a similar story of resilient quality characteristics but depressed valuations.
Timing of improved UK sentiment is unclear, but the re-rating potential is substantial.
While we are increasingly hopeful that policy changes – particularly for pension funds – will help boost UK market sentiment and flows, we ultimately have little visibility on what will catalyse an elimination of the UK valuation anomaly or when it will happen. However, what we can predict with much greater confidence is that when a re-rating towards long run averages and intrinsic value does occur, the potential upside is quite substantial.
In the meantime, our funds’ portfolios are – at the aggregate level – delivering healthy levels of growth, an attractive dividend yield and are supported by quality fundamentals.
KEY RISKS
Past performance does not predict future returns. You may get back less than you originally invested.
We recommend this fund is held long term (minimum period of 5 years). We recommend that you hold this fund as part of a diversified portfolio of investments.
The Funds managed by the Economic Advantage Team:
- May have a concentrated portfolio, i.e. hold a limited number of investments. If one of these investments falls in value this can have a greater impact on a Fund's value than if it held a larger number of investments.
- May encounter liquidity constraints from time to time. The spread between the price you buy and sell shares will reflect the less liquid nature of the underlying holdings.
- May invest in companies listed on the Alternative Investment Market (AIM) which is primarily for emerging or smaller companies. The rules are less demanding than those of the official List of the London Stock Exchange and therefore companies listed on AIM may carry a greater risk than a company with a full listing.
- May invest in smaller companies and may invest a small proportion (less than 10%) in unlisted securities. There may be liquidity constraints in these securities from time to time, i.e. in certain circumstances, a fund may not be able to sell a position for full value or at all in the short term. This may affect performance and could cause a fund to defer or suspend redemptions of its shares.
- Outside of normal conditions, may hold higher levels of cash which may be deposited with several credit counterparties (e.g. international banks). A credit risk arises should one or more of these counterparties be unable to return the deposited cash.
- May be exposed to Counterparty Risk: any derivative contract, including FX hedging, may be at risk if the counterparty fails.
The risks detailed above are reflective of the full range of Funds managed by the Economic Advantage Team and not all of the risks listed are applicable to each individual Fund. For the risks associated with an individual Fund, please refer to its Key Investor Information Document (KIID)/PRIIP KID.
The issue of units/shares in Liontrust Funds may be subject to an initial charge, which will have an impact on the realisable value of the investment, particularly in the short term. Investments should always be considered as long term.
DISCLAIMER
This material is issued by Liontrust Investment Partners LLP (2 Savoy Court, London WC2R 0EZ), authorised and regulated in the UK by the Financial Conduct Authority (FRN 518552) to undertake regulated investment business.
It should not be construed as advice for investment in any product or security mentioned, an offer to buy or sell units/shares of Funds mentioned, or a solicitation to purchase securities in any company or investment product. Examples of stocks are provided for general information only to demonstrate our investment philosophy. The investment being promoted is for units in a fund, not directly in the underlying assets.
This information and analysis is believed to be accurate at the time of publication, but is subject to change without notice. Whilst care has been taken in compiling the content, no representation or warranty is given, whether express or implied, by Liontrust as to its accuracy or completeness, including for external sources (which may have been used) which have not been verified.
This is a marketing communication. Before making an investment, you should read the relevant Prospectus and the Key Investor Information Document (KIID) and/or PRIIP/KID, which provide full product details including investment charges and risks. These documents can be obtained, free of charge, from www.liontrust.co.uk or direct from Liontrust. If you are not a professional investor please consult a regulated financial adviser regarding the suitability of such an investment for you and your personal circumstances.
