Liontrust Special Situations Fund

• Speculation around possible fiscal changes in upcoming Autumn Statement have affected sentiment towards UK Shares.
• Positive catalysts could emerge in the form of pension market reform and/or further M&A activity; the Fund’s holdings in Rightmove, TI Fluid Systems and Learning Technologies were targeted in Q3.
• Among company earnings updates, Haleon and Gamma Communications gave cause for optimism, but Next 15 Group fell heavily.

The Liontrust Special Situations Fund returned -0.2%*in Q3. The FTSE All-Share Index comparator benchmark returned 2.3% and the average return in the IA UK All Companies sector, also a comparator benchmark, was 2.3%.

A solid quarterly gain for the FTSE All-Share hides a fair amount of volatility during August as investor sentiment first weakened due to softer-than-expected US employment data– undermining confidence in a soft economic landing and reviving recession fears – before swiftly recovering on a clear indication from the US Federal Reserve that it would cut rates in September.

While the delivery of a 50 basis point cut in the US and a raft of stimulus measures in China buoyed global markets in September, the UK market was increasingly weighed down by policy uncertainty. The UK general election in July initially prompted enthusiasm at the prospect of greater political stability over the coming years, aided by the Labour government’s explicit agenda of driving economic growth. However, with the Autumn Statement approaching at the end of October and a negative slant to the rhetoric coming from the Treasury, concerns have been rising about the fine balance to be struck between resetting expectations but also avoiding a self-fulfilling spiral of negative sentiment weakening business confidence.

Very little has been trailed by the Chancellor about possible changes to the fiscal landscape ahead of the Autumn Statement, though speculation has been rife. Some, such as an increase to the rate of capital gains tax (CGT) or the removal of inheritance tax (IHT) exempt status on AIM-listed shares, have been met with concern. Without adding to speculation within the scope of this commentary, we maintain our passionate belief in the long-term advantages of investing in companies across the market cap scale with strong barriers to competition and high returns on capital, and that the quality of such businesses will ‘out’ over time. With extreme compression of valuation multiples of listed companies having occurred over the past few years – a dynamic felt most acutely at the small cap end of the size spectrum – our view is that any short-term disruption from the Autumn Statement should present an opportunity.

On the other hand, the event could well produce a powerful positive catalyst to UK markets in the form of pension market reform. Much has been written about the potential for concrete policy initiatives to reverse decades-long flows out of UK equities from domestic pension funds, and any such move would undoubtedly send a strong signal that the UK recognises the vital importance of its capital markets to economic growth and prosperity.

We have also commented at length in recent reviews on the high prevalence of inbound takeover interest for UK stock market listed companies, given their attractive absolute and relative valuations. While it is frustrating to see long-term Fund holdings targeted in opportunistic fashion at share price premia which fall short of their full valuation potential, M&A may well be a key mechanism through which the significant undervaluation of UK equities is both highlighted and closed out.

On top of the approaches seen so far in 2024 for Hargreaves Lansdown, Keywords Studios and Wood Group, Q3 saw three further portfolio holdings targeted: Rightmove, TI Fluid Systems and Learning Technologies Group.

Rightmove (+16%) shares leapt on the first trading day of September following confirmation of bid interest from REA, before giving up a lot of the ground gained as the approach was rejected and then withdrawn at the end of the month. REA Group is an Australian property specialist owning several residential, commercial and mortgage broking websites in its domestic market. It also has stakes in digital property portals in the US and Asia. Rightmove labelled REA’s initial cash-and-share proposal worth in the region 705p highly conditional and highly opportunistic. Although REA increased its indicative offer on three occasions to finish at a cash-and-shares package valued around 775p, Rightmove stood firm in its view that the offer materially undervalued its standalone prospects.

TI Fluid Systems (+28%) received two takeover offers from ABC Technologies, a Canadian electronic components distributor owned by private equity group Apollo. The automotive fluid systems specialist rejected both all-cash offers, pitched at 165p and 176p, a move that we welcomed given that the approach looked highly opportunistic, coming at a trough point in the economic cycle. The shares have hung on to their gains, trading at over 160p to reclaim the losses following a disappointing full-year results release in March.

“Highly opportunistic” is a phrase that could equally be applied to the conditional approach for Learning Technologies Group (+12%) which was tabled at 100p a share by US private equity vehicle General Atlantic during September. We were amazed and dismayed that the board of LTG indicated they were “minded to recommend unanimously” at that level. Recent trading has undoubtedly been beset by short term headwinds due to the impact of macroeconomic pressures; nevertheless, LTG were keen to emphasise – as recently as in its interim results published just ten days prior to the approach being made public – that “the structural drivers of the learning and talent development market remain intact and support our belief that LTG will return to growth when market conditions improve”.

As an indication of just how uninspiring the mooted 100p price tag appears, an independent research note from Canaccord Genuity Quest – whose cash flow return on capital (CFROC) data is used explicitly within the second stage of the Economic Advantage investment process – indicated a fair value range of between 169p and 199p for the shares, using only modest growth and margin assumptions.

Meanwhile, a very different stance was taken in respect of Wood Group (-36%). It has been subject to two separate drawn-out rounds of takeover bid activity over the past two years. In 2023, the engineering and consultancy group received five takeover proposals from private equity group Apollo, rejecting the first four but agreeing to enter discussions following the final cash proposal of 240p before Apollo dropped its interest. In a similar turn of events, Wood Group this year rejected three successive takeover proposals from Dubai-based group Sidara before agreeing to enter discussions over a fourth and final offer at 230p, only for Sidara to walk away in August citing rising geopolitical risks and financial market uncertainty. The Fund had been actively selling down its position ahead of Sidara walking away, due to persistent concerns over weak cashflow metrics, accounting ‘red flags’ and a high debt burden, and completed its exit during September.

Turning to company updates on trading, Next 15 Group (-42%) was a standout disappointment, as it issued a shock September profit warning which was triggered by the loss of a significant contract and a softening of client spending from its technology sector customers in particular. As a result, it expects profits for the financial year to 31 January 2025 to be significantly below its prior expectations. The data-driven growth consultancy’s Mach49 agency lost its largest customer, which unexpectedly terminated a contract that had been expected to continue for a further two years. The fund managers have since engaged at length with the company to form a better understanding of the factors at play, as well as steps that will be taken to return the company to a solid trading footing.

Mortgage Advice Bureau (-22%) saw its shares slide over the quarter due to weaker investor sentiment and specific concerns over how the business might be impacted by the FCA’s proposed market study into the sale of protection products. However, a half-year results release in late September prompted a partial recovery. The business saw a strong start to 2024 as mortgage rates fell to reflect expected base rate reductions, before activity tailed off as it became clear that cuts would be delayed and stayed subdued ahead of the UK general election. Nevertheless, Mortgage Advice Bureau grew revenue by 5% to £124 million while adjusted profit before tax rose 40% to £12.3 million. Since August’s rate cut from the Bank of England, activity and adviser numbers have begun to pick up again. The company expects significant refinancing activity in the second half of the year as well as a recovery in housing transaction. As a result, it has maintained its full-year financial guidance. Despite continuing volatility in the backdrop, the fund managers have been consistently impressed with the business’ ability to continue taking market share, with its share of new mortgage lending up to 8.2% at the half year.

Half-year results from Haleon (+22%), the consumer healthcare business spun out of GSK in 2022, were encouraging. Revenue growth of 3.5% was driven by price increases, with volumes slightly lower, although Q2 did see volume growth turn positive. Adjusted operating margins improved 160 basis points organically to 22.7%, helped by efficiency efforts and lower cost inflation, lifting adjusted operating profit by 11%. The company raised its full-year operating growth target to “high-single digit”.

Interim results from Gamma Communications (+19%) were also well received as the business telecoms provider commented that good growth in all business units leads it to expect full-year profits to be at the top end of analysts’ current consensus range. Gamma has demonstrated extraordinary resilience in trading of late against a tricky market backdrop, which has led the shares to perform well. These most recent results also included commentary that the board are considering moving the business’ listing to the main market of the London Stock Exchange after almost a decade listed on AIM. It is a move which serves as a timely reminder of the important role that the London junior stock market is able to play for ambitious growth businesses at the right stage of their journey.

AJ Bell (+19%) was another to rise strongly. A Q3 trading update revealed that customer numbers rose 5% over the quarter and 13% annually to 528,000. Assets under administration have risen 4% in the quarter and 20% over a year to £83.7 billion, following new inflows of £1.7 billion in Q3. Its direct customer business saw particularly strong customer growth of 7% in the quarter. AJ Bell attributed this to rising investor confidence in light of good recent stock market performance, a trend which has also driven higher levels of dealing activity, especially for international securities. 

While the background macroeconomic picture remains somewhat volatile, UK equities continue to trade at a substantial discount to their intrinsic value and to their long run average, providing attractive opportunities for investors able to take a longer-term view. We remain convinced that it is only a matter of time until this gap begins to close. In the meantime, although there are pockets of trading weakness from companies more exposed to cyclical demand pressures, overall the Fund’s companies remain insulated by their superior quality characteristics, continuing to demonstrate higher returns on capital, higher margins and lower leverage than the wider market.

Positive contributors included:

TI Fluid Systems (+28%), Coats Group (+27%), Haleon (+22%), Gamma Communications (+19%) and TP ICAP (+18%).

Negative contributors included:

Next 15 Group (-42%), Wood Group (-36%), Mortgage Advice Bureau (-22%), Big Technologies (-20%) and Kainos Group (-17%).

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

*Source: Financial Express, as at 30.09.24, total return (net of fees and income reinvested), bid-to-bid, institutional class. **Source: Financial Express, as at 30.09.24, total return (net of fees and income reinvested), bid-to-bid, primary class.