Liontrust Special Situations Fund

The Liontrust Special Situations Fund returned -4.8%* in September. The FTSE All-Share Index comparator benchmark returned -5.9% and the average return in the IA UK All Companies sector, also a comparator benchmark, was -7.1%.

A higher-than-expected US inflation reading (8.3% for August) removed any small possibility that inflation would drop out of investors’ key concerns during September. The US Federal Reserve reacted by raising rates a further 75 basis points – its third consecutive hike of this size – and commenting that further economic pain was likely as more tightening is implemented

Equity markets softened and government bond yields rose, trends which were accentuated in the UK towards the end of the month by an adverse market reaction to UK Chancellor Kwasi Kwarteng’s ‘mini-budget’. Having already committed support worth an estimated £150bn to cap household energy bills, the Chancellor went on to announce a package of fiscal stimulus which included around £45bn of tax cuts. Additional borrowing of £72bn will be needed this year to support the plans; markets signalled strongly that they viewed the measures as damaging to the UK’s credit quality. In trade-weighted terms, the pound lost almost 5% to its low on 26^th September. UK Government bonds sold off extremely sharply, with, for example, the 5 year bond hitting a high of 4.7% on 27^th, up nearly 200 percentage points on the month and up by around 110 points since the budget announcement a couple of days earlier. At this point, the Bank of England moved to stabilise markets – temporarily reinstating its bond-buying quantitative easing efforts – over fears of potential systemic solvency issues for some pension funds.

On the UK equity market, these events only served to deepen the year’s existing trend of weakness concentrated in mid and small caps. While the large-cap FTSE 100 monthly return of -5.2% was bad enough, the mid-cap FTSE 250 returned -9.7% and the FTSE Small Cap registered -8.5%.

Earlier in the year, share weakness in these areas seemed to stem predominantly from ratings contracting – i.e. the ‘p’ in p/e levels falling – as investors priced in higher interest rates (and discount rates) on future expected growth. More recently, as recessionary forces have built, earnings estimates have come under pressure, prompting further share price weakness.

It is understandable that the market might be concerned that mid and small-caps in aggregate would be disproportionately affected by the problems faced by the UK’s domestic economy. While we by no means claim that any of our companies will be immune from a contraction in the UK economy, we have so far been reassured by the trading resilience shown by many of them. Over time, we would expect their high-quality characteristics to allow them to outperform the average company, especially against a tough economic backdrop.

Inevitably, markets use a very broad brush when reacting to economic developments and do not differentiate between different companies until later in the cycle when the successful ones are able to show, by their delivered results, their superiority. We believe that our funds are invested in dependable, consistent businesses in possession of barriers to competition which gives them pricing power. This pricing power is likely to prove critical in dealing with cost pressures that look set to persist for some time.

In the meantime, we have been trying to view the UK market sell-off as a period of disruption which should present investment opportunities, particularly lower down the size scale. We have been looking for opportunities to initiate or top-up positions in high quality, strong businesses with Economic Advantage characteristics at materially cheaper levels than we were able to at the start of the year.

So far this year we’ve added new smaller company positions in the form of Team 17, Focusrite and Midwich, while we’ve been able to top-up into some existing holdings which have experienced particularly hard share price falls.

This month, the hardest hit stock was Mortgage Advice Bureau (MAB, -33%). Its interim results showed that although average mainstream adviser numbers rose 19% year-on-year to 1,890, revenue per adviser was down 13%. The company commented that pipelines are taking longer to convert, partly due to the 2021 comparable being boosted by stamp duty holiday changes which accelerated mortgage completions. While MAB hopes that new stamp duty reductions announced in the mini-budget will support the market, it still forecasts a further softening of purchase activity and slow pipeline conversion, which feeds through to a small downgrade to its full-year financial guidance. The investor reaction to the budget was more unequivocal, with a slowdown in the UK residential market widely expected as a result of sharp upwards rebasing of mortgage rates and the withdrawal of swathes of products. 

Moonpig (-19%) shares also fell heavily despite an AGM update describing trading since 30 April as in line with its expectations and on track to meet full-year financial guidance. Investors looking for signs of exposure to weakening consumer spending may have focused on its decision to prioritise greeting card sales over gifts due to their greater historic resilience to economic downturns. Moonpig also reassured that margin trends remain resilient, with no significant pressure from input cost inflation. 

Smart Metering Systems (-12%) was another to drop amid a very tough market environment, despite trading appearing relatively robust. It reported an 11% year-on-year increase in its preferred top-line measure of index-linked annualised recurring revenue (to £93m) in the first half of 2022. For the last quarter, smart meter installations have risen to a run rate of over 40,00 a month, up from the 30,000 average during the 2021 financial year. Its total smart meter portfolio has risen to 1.9 million, up from 1.7 million. The company still expects 2022 earnings to be in line with the upgraded guidance it gave in July.

The portfolio’s handful of risers was led by interdealer broker TP ICAP (+27%), which often benefits from market volatility. Within last month’s interims it commented that its Rates division had been very profitable and would benefit further were activity to pick up at the long end of the bond yield curve.

Craneware (+22%) delivered the robust set of full-year results promised in a July trading update. In the period to 30 June 2022, acquisitions helped it increase revenue by 119% to $166m while adjusted EBITDA rose 91% to $51.8m. While it recognises the challenging macroeconomic backdrop, Craneware states it still remains confident of delivering further strong performance. As a company whose revenues are almost exclusively generated in US dollars, shares in the company may have derived some strength from the potential benefits of dollar appreciation relative to sterling.

Within interim results, Big Technologies (+21%) issued full-year guidance of at least £48m in revenue with an adjusted EBITDA margin of more than 58%, ahead of market expectations. The provider of integrated hardware/software solutions for the electronic monitoring of criminal offenders reported a 27% increase in first-half revenues to £22.9m following new contract wins and more business from existing customers.

There was also a positive monthly return for Haleon (+7.9%) after its maiden set of results as an independent listed company following its spin-off from GlaxoSmithKline, a long-standing fund holding. We received shares in Haleon as part of the spin-off and have since topped it up to target position size. As with GlaxoSmithKline, we believe it possesses intangible barriers to competition in the form of intellectual property and distribution network strength.

Positive contributors included:

TP ICAP (+27%), Craneware (+22%), Big Technologies (+21%), Hargreaves Lansdown (+9.6%) and Haleon (+7.9%)

Negative contributors included:

Mortgage Advice Bureau (-33%), Integrafin Holdings (-18%), TI Fluid Systems (-17%), Savills (-15%) and Coats (-15%)

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

Past performance does not predict future returns

*Source: Financial Express, as at 30.09.22, total return (net of fees and income reinvested), bid-to-bid, institutional class.

**Source: Financial Express, as at 30.09.22, total return (net of fees and income reinvested), bid-to-bid, primary class.

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.

Some of the Funds managed by the Economic Advantage team invest primarily in smaller companies and companies traded on the Alternative Investment Market.  These stocks may be less liquid and the price swings greater than those in, for example, larger companies.

DISCLAIMER

This is a marketing communication. Before making an investment, you should read the relevant Prospectus and the Key Investor Information Document (KIID), 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. Always research your own investments. 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.

This 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. It contains information and analysis that 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 of this document, no representation or warranty, express or implied, is made by Liontrust as to its accuracy or completeness, including for external sources (which may have been used) which have not been verified. It should not be copied, forwarded, reproduced, divulged or otherwise distributed in any form whether by way of fax, email, oral or otherwise, in whole or in part without the express and prior written consent of Liontrust.