Liontrust UK Smaller Companies 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 holding in Learning Technologies was targeted in September.
• Among company earnings updates, Big Technologies gave cause for optimism, but Next 15 Group fell heavily.

The Liontrust UK Smaller Companies Fund returned -5.6%* in September. The FTSE Small Cap (excluding investment trusts) Index comparator benchmark returned -0.2% and 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.

We have 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’s 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 Mattioli Woods and Smart Metering Systems, September saw Learning Technologies Group targeted.

A very opportunistic conditional approach for Learning Technologies Group (+37%) was tabled at 100p a share by US private equity vehicle General Atlantic during the month. 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.

The takeover of Mattioli Woods by private equity group Pollen Street Capital completed in September, so the position exited the portfolio.

Turning to company updates on trading, Next 15 Group (-47%) was a standout disappointment during the month, 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. We 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. In a trading update, Kainos Group (-20%) said that although it expects to deliver adjusted profits in line with expectations for the year to 31 March 2025, it now sees revenues falling short of consensus forecasts with only a small increase. The outsourced provider of IT design and support services has seen solid demand from public sector clients of its Digital Services division but weaker trends at Workday Services, which provides finance, HR and planning enterprise solutions. In this division, contract win rates have been maintained but volumes and values have been lower.

Big Technologies’ (+16%) set of interim results provided grounds for optimism. The company provides integrated hardware and software solutions for the electronic monitoring of criminal offenders. As it had previously flagged, revenues in the first half of 2024 were held back by the expiry of a large Colombian contract which had previously seen a number of short-term renewals. While interim results reported a 3% decline over the six months and pointed to full-year results which will be at the lower end of analysts’ current expectations, investors found cause for optimism within the statement. One of the brighter areas is the US, where Big Technologies’ significant expansion efforts in 2023 have begun to yield some results, with a number of accounts secured in the first half of 2024. 

Mortgage Advice Bureau (-18%) has seen its share price slide over the last two months due to a combination of the aforementioned 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.

Elsewhere in the portfolio, smaller but still significant monthly share price moves included: Alpha Group International (-14%), which released in-line interim results but also announced the resignation of its founder and long-time CEO; 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 Cohort (+7.0%), whose bullish AGM update commented on strong growth in the first few months of its new financial year.

Positive contributors included:

Learning Technologies Group (+37%), Big Technologies (+16%), EKF Diagnostics (+9.1%), Kitwave Group (+7.4) and Cohort (+7.0%)

Negative contributors included:

Next 15 Group (-47%), Kainos Group (-20%), Mortgage Advice Bureau (-18%), Tristel (-17%) and Alpha Group International (-14%).

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.

^† 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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