Liontrust UK Micro Cap Fund

• Speculation around possible fiscal changes in upcoming Autumn Statement has affected sentiment towards UK Shares. 
• As a result, AIM market constituents saw broad-based weakness, with many of the Fund’s holdings affected.
• Positive catalysts could emerge in the form of pension market reform and/or further M&A activity.

The Liontrust UK Micro Cap Fund returned -4.6%* in Q3. The FTSE Small Cap (excluding investment trusts) Index and the FTSE AIM All-Share Index comparator benchmarks returned 6.2% and -2.7% respectively. The average return of funds in the IA UK Smaller Companies sector, also a comparator benchmark, was -0.2%.

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 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, there is a growing optimism that a powerful positive catalyst to UK markets may emerge 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.

While AIM market constituents saw broad based weakness, those reporting any trading headwinds were heavily penalised. Gift wrap and greetings card manufacturer IG Design Group (-43%) was one of these. It is going through a restructuring process as a new management team attempts to navigate through a period of consumer caution around spending. Shares in the company had rallied very strongly in May as full-year results showed evidence of good strategic progress, with profitability boosted by cost cutting efforts in the face of declining revenues.

However, a September trading update saw the reversal of these gains as it became clear that top-line pressures are more sustained than anticipated. Its Americas division in particular is seeing a softening of demand, and the company now expects group revenues for the year to 31 March 2025 to fall by 5%. While it’s focus on improving margins is still expected to generate over 20% growth in adjusted profits, it is likely to be up to 10% below analysts’ consensus forecasts as a result of the weaker revenue outlook

Oxford Metrics (-40%) also warned on profits, as a trend towards more extended buying cycles in the second half of its financial year has delayed decisions on a number of pipeline contracts. The designer of smart sensors announced that revenues in the year to 30 September were between £40 million and £42 million – about 15% below forecasts – while profits would be “materially below” market expectations. The company maintains a significant net cash position of c. £50 million compared to a market capitalisation of £76 million.

Zoo Digital Group (-44%) characterised the year to 31 March 2024 as “an extremely challenging year for the film and television entertainment industry and all those businesses that operate in this wider ecosystem”. As has been flagged in a series of investor updates, Zoo Digital’s revenues were heavily hit, with August’s full-year results showing a 55% fall to $41 million. Sales have since recovered strongly and Zoo Digital expects to hit its former levels of activity by late 2025, although it notes that trading visibility remains short.

Leading the Fund’s quarterly risers was cyber security software specialist Intercede Group (+52%), which has had an excellent 2024 so far. Early in the year it upgraded financial guidance on the strength of trading, before June’s interims consolidated share price gains with a positive update on its acquisitive growth strategy as well as upbeat comments on pipeline visibility. In August, it announced a strategic partnership with Microsoft to combine Intercede’s credential management systems with Microsoft Entra ID to allow enterprise administrators to create phishing-resistant FIDO (Fast IDentity Online) passkeys. Although no financial details were disclosed in the announcement, the potential impact of the agreement is very significant, a fact reflected in the shares 36% monthly gain.

Beeks Financial Cloud Group (+48%) was close behind. The financial markets cloud computing and connectivity provider deepened its relationship with the Johannesburg Stock Exchange during the quarter. Beeks originally launched services with JSE in September 2023 before receiving a large contract extension in March 2024 due to stronger-than-anticipated customer demand. The contract has now been extended to include JSE’s Terco data centre over a multi-year period. Beeks also confirmed that the provisional cloud contract with “one of the largest exchange groups globally” – initially announced in February – has now commenced having received regulatory approval and service deployment.

Shares in Crimson Tide (-52%) suffered a large fall during the quarter, although this was simply June’s bid excitement reversing. The provider of cloud-based mobile workflow solutions received takeover interest, initially from Checkit – an augmented workflow and smart sensor automation company proposing an all-share deal – but more significant interest then emerged in the form of a potential 312p a share cash bid from Ideagen. While Crimson Tide’s board rejected Checkit’s approach, it indicated it was considering Ideagen’s offer – leading its shares to jump to around 270p. However, July’s announcement that Ideagen had withdrawn its bid interest led these gains to be reversed.

Nexteq’s (-25%) fall stems from disappointing trading and the overall of its management team. Nexteq’s Quixant division supplies computer platforms for the casino gaming and slot machine market, while its Denistron business provides display components into a diverse range of industrial sectors. Both units have seen soft demand in the first half of 2024, and Nexteq has cut full-year financial guidance as a result.

With regard to the management changes, Nexteq states that departures of its Chair, CEO and CFO are amicable, but it would be reasonable to assume that there has been some level of disagreement at Board level. We have engaged with Deputy Chair, to seek reassurance that the strength in the operational management team below Board level mitigates the potential disruption to the day-to-day running of the business, but clearly it is important that the positions are filled in a timely manner and by the right candidates.

Returning to more positive news, shares in Totally (+28%) rallied on contract news. The frontline healthcare services provider has been through an exceptionally tough period, suffering delays in the re-tender process for some expiring contracts and high costs due to clinical workforce shortages leading to a greater reliance on agency staff. Some of the recent hesitancy from clients resulted from election uncertainty, so it was pleasing to see the announcement of multiple contracts being extended in July.

Inspiration Healthcare Group (+23%) shares had also had a tough first half of 2024 due to a delay in receiving a large export order. In May, the company stated that while it still expects to receive the order this financial year, it had to seek waivers from end-April covenant tests on its debt, adjust covenants due next year and raise funds of £3 million. Investors were therefore relieved to see July’s announcement that the contract has now been signed. Inspiration will delivery SLE6000 neonatal ventilators, First Breath Humidification and other accessories in a deal worth $4.3 million – the largest single order for the SLE6000 ventilators.

A position was initiated in Facilities by ADF during the period under review. ADF is a market leader provider of equipment and services to the UK film and TV industry. The Fund participated in a capital raise to acquire AutoTrak, a leading provider of portable roadway products to the UK film and TV sector.

We feel that there is currently a compelling opportunity for investors in UK shares. The UK is at a clear valuation discount to historic averages and measures of intrinsic value but there is the potential for government policy intervention (focused on pension fund domestic equity allocations in particular) to help turn the tide of investor sentiment and capital flows, which would be of particular benefit to smaller company valuations.

Whilst the re-rating potential of UK equities, small caps in particular, is significant, the timing and magnitude of the catalysts remains uncertain. In the meantime, we are optimistic about the portfolio’s ability to continue to deliver attractive compounding longer term investment returns supported by an attractive combination of earnings growth and increasingly shareholder yield (both dividend and share buybacks).

Positive contributors included:

Intercede (+52%), Beeks Financial Cloud Group (+48%), Totally (+28%), Inspiration Healthcare (+23%) and ActiveOps (+12%).

Negative contributors included:

Crimson Tide (-52%), Zoo Digital Group (-44%), IG Design Group (-43%), Oxford Metrics (-40%) and Nexteq (-25%).

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, institutional class.