Liontrust UK Micro Cap Fund

• Speculation around possible fiscal changes in upcoming Autumn Statement have 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 -7.8%* in September. The FTSE Small Cap (excluding investment trusts) Index and the FTSE AIM All-Share Index comparator benchmarks returned -0.2% and -4.0% respectively. The average return of funds in the IA UK Smaller Companies sector, also a comparator benchmark, was -3.4%.

While global equity markets were focused on the US interest rate decision – which delivered the increasingly anticipated 50 basis point cut – before being buoyed by a raft of stimulus measures in China, UK markets drifted during September. 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, the fund managers maintain their 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.

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 (-36%) 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 (-27%) 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.

For Churchill China (-21%), the first half of 2024 saw an 8% fall in revenues – a reflection of subdued global hospitality markets and a 2023 comparable period which benefitted from a chunk of its order book being processed. The manufacturer of durable tableware has said it is now dependent on a repeat of the stronger demand typically experienced in the final four month of the year in order to hit its full-year expectations. In an environment of heightened risk aversion on the AIM market, this lack of short-term reassurance was penalised fairly heavily.

Zoo Digital Group (-21%) commented on a strong recovery in its pipeline as the media streaming sector recovers from the 2023 entertainment industry strikes. The provider of localisation and other media services saw sales growth of 28% in the six months to 30 September, putting it on track to return to profit at the EBITDA level. However, while management noted that a lack of visibility beyond January is a normal feature of its business, some investors seem perturbed by its comment that meeting full-year expectations foe the period to 31 March 2025 would require further profitable progress.

Elsewhere in the portfolio, smaller but still significant monthly share price moves included: James Cropper (+9.8%), after an AGM update indicated trends for the advanced materials and packaging group had improved from the challenging conditions seen in the second half of its last financial year; EKF Diagnostics (+9.1%), whose half-year results were in-line with expectations and on track to meet full-year forecasts; Kitwave Group (+7.4%), which saw good trading over the four months to 31 August and also raised £31 million in a share placing to support a £60 million acquisition of Creed Catering Supplies, a family owned wholesaler specialising in leisure, hospitality, education and care sectors; and Eagle Eye Solutions (+1.8%), which released solid full year results and announced a five-year contract win with a UK retailer.

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.

Positive contributors included:

James Cropper (+9.8%), EKF Diagnostics (+9.1%), Kitwave Group (+7.4%), Bigblu Broadband (+5.4%) and Eagle Eye Solutions (+1.8%).

Negative contributors included:

IG Design Group (-36%), Oxford Metrics (-27%), Churchill China (-21%), Zoo Digital Group (-21%) and Tristel (-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, institutional class.

^† Julian Fosh is on a leave of absence. The Economic Advantage funds continue to be managed by the other members of the team in Julian’s absence.

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.

The Fund may invest in companies listed on the Alternative Investment Market (AIM) which is primarily for emerging or smaller companies. The rules are less demanding than those of the official List of the London Stock Exchange and therefore companies listed on AIM may carry a greater risk than a company with a full listing. As the Fund is primarily exposed to smaller companies there may be liquidity constraints from time to time, i.e. in certain circumstances, the fund may not be able to sell a position for full value or at all in the short term. This may affect performance and could cause the fund to defer or suspend redemptions of its shares. In addition the spread between the price you buy and sell units will reflect the less liquid nature of the underlying holdings. Outside of normal conditions, the Fund may hold higher levels of cash which may be deposited with several credit counterparties (e.g. international banks). A credit risk arises should one or more of these counterparties be unable to return the deposited cash. Counterparty Risk: any derivative contract, including FX hedging, may be at risk if the counterparty fails.

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