Liontrust UK Growth 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 and TI Fluid Systems were targeted in Q3.
• The Fund faced Q3 headwinds in the form of weakness in energy and pharma sectors – overweight positions for the portfolio.

The Liontrust GF UK Growth Fund returned -0.9%* in Q3. The Fund’s comparator benchmark, the FTSE All-Share, returned 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. Without adding to such 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 more acutely at the small and mid 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 Rightmove and TI Fluid Systems targeted.

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.

Meanwhile, Wood Group (-36%) 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.

Much of the Fund’s negative return in the quarter can be attributed to weakness in energy and pharma sectors, areas to which the Fund is overweight relative to the index.

The Brent crude oil price dropped 17% to finish September at $71.7 a barrel as oversupply concerns rose in light of plans by the OPEC+ group to increase production from December in combination with an uncertain global economic growth outlook. The raft of measures introduced in China to boost its economy made little impact on the oil price, while the extra geopolitical risk from events in the Middle East – usually reflected in higher oil prices – also failed to stem the slide. The Fund’s positions in Shell (-14%) and BP (-16%) were affected.

Within healthcare there was a disappointing Q2 update from Indivior (-14%), warning that sales growth of its Sublocade opioid addiction treatment is being significantly constrained by the headwind of Medicaid patient disenrollments. There had previously been automatic Medicaid coverage renewals in place in the US as part of Covid emergency measures, but these have now lapsed. Sublocade now accounts for around two-thirds of Indivior’s sales; although it is still expected to grow by around 25% in 2024, this is down on the 35% expected as of its late-May trading update. As a consequence, Indivior’s 2024 net revenue guidance has been cut from a $1.24 billion – $1.33 billion range (c.18% year-on-year growth) to $1.15 billion - $1.22 billion.

Indivior and AstraZeneca (-5.6%) went on to suffer September drug development setbacks in their respective treatments for cannabis use disorders and lung cancer.

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.

Countering this was a large gain for WH Smith (+30%) as consecutive quarterly trading updates delivered good news. Initially, it outlined 4% like-for-like growth in the 13 weeks to 1 June, once again driven by its travel division – up 5% like-for-like and 8% overall - while its legacy high street shops saw a further 1% like-for-like decline. In September, it then confirmed strong trading in the final quarter to 31 August – its seasonally busiest period – leaving it on track to meet market expectations for the year. It also disclosed a £75 million cash rebate as a result of transferring away responsibility for its defined benefit pension scheme. As a result, the company is planning to return around £50 million of surplus capital to shareholders via a share buyback scheme.

Half-year results from Haleon (+22%), the consumer healthcare business spun out of GSK in 2022, were also 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 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.

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:

WH Smith (+30%), TI Fluid Systems (+28%), Coats Group (+27%), Haleon (+22%) and Gamma Communications (+19%).

Negative contributors included:

Next 15 Group (-42%), Indivior (-41%), Wood Group (-36%), BP (-16%) and Shell (-14%).

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

*Source: Financial Express, as at 30.09.24, total return (net of fees and income reinvested), sterling terms, C3 institutional class. Non fund-related return data sourced from Bloomberg. **Source: Financial Express, as at 30.09.24, total return (net of fees and income reinvested), primary class. Investment decisions should not be based on short-term performance.