Liontrust Income Fund Q4 2021 review | Insights | Liontrust Asset Management PLC

Past performance does not predict future returns. You may get back less than you originally invested. Reference to specific securities is not intended as a recommendation to purchase or sell any investment.

The Liontrust Income Fund returned 4.8% in the fourth quarter of 2021, outperforming the 4.2% return of the FTSE All Share index. The average Fund in the IA UK Equity Income sector returned 3.2% in the three months ending December, placing the Liontrust Income Fund in the top quartile for Q4 and second quartile for the year*.

UK equities rose over the course of the fourth quarter, notwithstanding another Covid-19 variant wobble, which we are all becoming unduly well acquainted with. Stocks edged higher in October and the first half of November, aided by a broadly strong Q3 earnings season, before selling off on news from South Africa about the emergence of the Omicron variant. Oil fell below $70 a barrel, reversing energy stocks’ gains of the previous two months.

Travel and leisure names saw a faint initial recovery on hopes that Omicron would prove more mild than past Covid strains, but sold off again as December progressed and UK cases hit record highs. More defensive sectors, such as consumer staples, outperformed. Optimism returned to the market over Christmas, leaving investors with some festive cheer at the quarter end.

Despite the emergence of Omicron and disappointing GDP growth in October, the Bank of England surprised market participants in December by hiking interest rates by 0.25% to combat inflation. Headline inflation reached 5.1% in November (4% on a core basis), as companies across the industry spectrum – from retailers to construction to auto-manufacturers – continued to cite supply chain disruptions, raw material cost increases, and labour shortages. As one might expect, companies in the financials sector − led by the banks − responded positively to the move and prospects of higher net interest income.

Overall, there was no significant style bias in the quarter, as the opposing forces of interest rate increases (supporting value stocks) and rising omicron variant concerns (supporting more defensive & growth stocks) effectively neutralized one another.

Corporate cash levels continued to climb throughout the quarter, supporting shareholder returns in the form of dividends and buybacks. Ending the quarter, corporate cash as a percentage of total firm assets for FTSE All Share firms hit multi-year highs at 15%. Consequently, dividends continued the recovery trend of the prior two quarters, helped by handful of dividend reinstatements although the lion’s share of this benefit occurred in Q2 of this year. Link Group estimates that underlying dividends (excluding specials) rose to £77.4bn for the full year, implying a recovery in underlying payouts to the tune of 80% 2019 levels at year end. Crucially, dividends have returned to the market at more sustainable levels than pre-crisis − on our calculations the dividend cover of the FTSE All Share was around 1.4x in January, improving to 1.9x in Q4, which bodes well for dividend growth in 2022.

Consumer discretionary and information technology were the two greatest contributors to Fund performance in the quarter from a sector basis, with materials being a key detractor, as well as our underexposure to real estate and utilities.

Within consumer discretionary, Compass Group, our sole addition to the portfolio in Q4, performed well. A strong Q3 trading update showed encouraging signs of an uptick in catering outsourcing as well as market share gains. Confidence was reflected by management in the decision to restore the dividend. Elsewhere, software company Sage Group lifted performance as it reported higher levels of recurring revenues, signaling that investment in marketing and innovation is paying off and that the company’s transition to cloud-based revenues has further to run. Other notable contributors to performance include mid-market PE investment group 3i, whose portfolio net asset value returned to long term trends, as well as our oversees investments in US technology companies Motorola Solutions, Apple and Microsoft.

The largest detractor from performance was Johnson Matthey, the specialty chemicals company best known for its manufacturing of catalysts. The group’s decision to exit the battery materials market in November precipitated a 20% intra-day decline in the share price; the rationale provided to shareholders was an increasing commoditization in the battery materials industry amid growing capital intensity. Whilst we support the decision to withdraw from an arena no longer offering attractive returns on capital, we will look for a clear strategy formed around JM’s core competencies in catalysis and hydrogen from the incoming CEO.

Elsewhere, other detractors for the quarter included The London Stock exchange, which, despite posting reasonably in-line results, has failed to reignite investor sentiment since its warning in February of higher-than-expected integration costs associated with the acquisition of Refinitiv. Asset manager abrdn plc was also punished after announcing the acquisition of Interactive Investor (ii), the second largest D2C UK fund supermarket. Despite being a strategic pivot to a higher growth arena in asset management, the price paid for ii was deemed high (especially considering the increasing competition in the space) and the deal was thus received poorly by investors.

At the start of 2021, in its Monetary Policy Report, the Bank of England projected that ‘inflation should return to around our 2% target later this year’ as oil and gas prices regained momentum lost in 2020 and economic growth rebounded. By the end of the year, they were warning of inflation peaking at 6% in the Spring. Aside from the obvious read that inflationary pressures will persist into the first half of the year, this highlights the difficulty in forecasting in the current environment.

The impacts of inflation and related monetary policy indicate that the more ‘value’ oriented companies may fare better in a rising rate environment, with growth stocks more disproportionately hit by increasing rates owing to greater expected future cashflows being discounted at a higher rate. Nonetheless, as we have seen with the emergence of different Covid variants and flight to ‘quality’, defensive stocks, this can quickly reverse course. For our part, we maintain our style agnostic approach to portfolio construction and belief in the power of diversification, accepting that our ‘Steady Eddies’, ‘Hidden Fruits’ and ‘Economic Recovery stocks’ will perform at different points in the market cycle.

We are optimistic about UK equity income for two key reasons, the first being the compelling relative valuation UK equities offer to other global developed markets. The UK has de-rated significantly since the 2016 Brexit vote, and is currently trading at three decade lows versus the MSCI World Index on a forward price/ earnings basis. This is despite forward-looking earnings rebounding at a faster pace than other developed markets in 2021, and we see potential for UK companies to deliver good earnings growth into 2022 given positive earnings surprise momentum. A backdrop of negative real rates is supportive of equities with decent income yields which can offer potential real yield and growth; the FTSE 100 looks particularly attractive on a 2022 indicated dividend yield of 4.1% (ahead of the FTSE All Share’s 3.5%), which could work to the Fund’s favour given its large cap bias.

The second cause for optimism is the return of dividend. In the UK, dividends have recovered ahead of initial forecasts, and Link Group now expects a return to pre-crisis levels by 2024, a year sooner than previously estimated. We expect the dividend recovery theme of 2021 to continue into 2022, but at a less extreme pace. The FTSE indices will be losing some big income hitters – BHP and Morrisons – so anticipated total dividend growth of 2% is better than the optics suggest and may well prove conservative given the largely stronger balance sheets and cash positions on UK companies today compared to a year ago. The Liontrust income Fund’s dividend increased by 1.5% year-on-year in Q4, meaning three-year annualised growth is 11.4%, and we see good potential for dividend growth in 2022 considering lower than historical average payout ratios across the market.

Discrete years' performance (%)**, to previous quarter-end:

	Dec-21	Dec-20	Dec-19	Dec-18	Dec-17
Liontrust Income C Acc	17.6%	-8.5%	15.2%	-3.4%	11.6%
FTSE All Share	18.3%	-9.8%	19.2%	-9.5%	13.1%
IA UK Equity Income	18.4%	-10.7%	20.1%	-10.5%	11.3%
Quartile	2	2	4	1	3

*Source: FE Analytics as at 31.12.21

**Source: FE Analytics as at 31.12.21. Quartiles generated on 12.01.22

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Key Risks

Past performance is not a guide to future performance. The value of an investment and the income generated from it can fall as well as rise and is not guaranteed. You may get back less than you originally invested. 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.

Investment in funds managed by the Global Equity (GE) team may involve investment in smaller companies - these stocks may be less liquid and the price swings greater than those in, for example, larger companies. Investment in funds managed by the GE team may involve foreign currencies and may be subject to fluctuations in value due to movements in exchange rates. The team may invest in emerging markets/soft currencies or in financial derivative instruments, both of which may have the effect of increasing volatility. Some of the funds managed by the GE team hold a concentrated portfolio of stocks, meaning that if the price of one of these stocks should move significantly, this may have a notable effect on the value of that portfolio.

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