Liontrust US Opportunities Fund

• Volatile quarter included an unwinding of crowded trades, such as AI capacity buildout.
• A number of the Fund’s technology stocks were affected by the associated softening in investor sentiment towards the sector; Omnicell and Frontdoor were among the stronger performers. 
• A broadening of market leadership in Q4 should provide a fertile environment for stock-picking approaches to add alpha.

Over the quarter, the Liontrust US Opportunities Fund* returned -5.9% over the quarter, compared with the -0.3% return from the S&P 500 Index and -0.1% average return in the IA North America sector, its comparator benchmarks.

Market backdrop

The third quarter of 2024 was not a period for the fainthearted as markets whipsawed their way through the summer. Volatility was everywhere but nowhere more so than the Nikkei 225 in Japan, which fell 25% from mid-July to early August, including a 17% two-day fall as markets appeared to succumb to a 1987-like liquidity event.  

Assets across the world reacted in tandem, with the US SOX semiconductor index in particular falling 25% peak to trough, reflecting a general move towards derisking of the most crowded trades (in this case the big AI capacity buildout). Even the US mega-cap constellation saw profit taking and a quarter of underperformance.

At the same time, interest rate markets were moving dramatically to price in a 50 basis points (bps) cut by the Federal Reserve in September. The short end (US 2-year bonds) saw yields fall a whopping 115 bps from 4.75% at the start of the quarter to 3.60 % at the end.  In commodities, gold rose 14% in the quarter to complete a four-quarter winning run and hit new all-time highs, while oil fell 18% - perhaps taking its cue more from expected global economic weakness than the rising tensions in the Middle East.

All in all, the quarter was an ambiguous juxtaposition of asset price moves that left many wondering what the path to year end would really look like.

Portfolio review

The Fund’s moderate overweight to technology left it exposed to weakening sentiment as investors paused to give the sector’s AI-fuelled gains more scrutiny. As well as AI bellwether Nvidia (-7.4%), the portfolio’s ten largest detractors over Q3 also included Micron Technology (-26%), CrowdStrike (-22%), Intuit (-11%) and Microsoft (-9.2%) from the tech sector. CrowdStrike’s share price weakness stemmed from a faulty software update responsible for one of the largest ever global IT outages. Although its subsequent Q2 results announcement in August quantified the sales impact at only a few percent this year, investors marked down the shares heavily.

The Fund’s healthcare exposure also detracted, not helped by a large fall at DexCom (-44%) after a Q2 update cut 2024 sales guidance to 11% to 13% organic growth, down from the 17% to 21% range given in April’s Q1 announcement.

The portfolio’s strongest holding was PayPal (+27%), which moved higher on the back of quarterly results. In the three months to 30 June, operating profit rose 17% as margins expanded 126bps, ahead of expectations and strong enough to prompt an upgrade to full-year guidance. PayPal is now targeting “low to mid-teens” percentage growth in earnings per share, up from “mid-to-high single digit” guidance given in April.

Likewise, Frontdoor (+34%) – the US home warranty provider – upgraded 2024 earnings targets after price increases drove quarterly revenue growth in the face of lower volumes. Omnicell (+52%) was another notable gainer as better-then-expected quarterly results included upgrades to full-year guidance; the provider of automated medication management systems lifted earnings guidance by about 10%

Portfolio trades

We added several new holdings to broaden exposure across sectors and themes. These were funded by trimming existing holdings, and exiting CrowdStrike where we see near term challenges. We also exited Apple, where we believe the valuation is baking in a very optimistic growth scenario.

Gold is a proven hedge against inflation and instability. Given the uncertain global geopolitical and macroeconomic picture we have added holdings in Barrick Gold and Newmont Mining, two large scale gold miners where we see near term production growth and strong management teams with good track records at containing costs.

Elsewhere, in the healthcare sector we added GoodRx, a digital platform that helps US consumers navigate the increasingly complex US prescription pricing system.  Wayfair was added to provide exposure in the challenged home furnishings space. Its growth has been relatively resilient, and it is well place for an environment where economic headwinds subside. Another addition was Trimble, which provides several hardware and software related solutions to the construction, agriculture and transportation industries. The company is undergoing a shift from being reliant on hardware sales to becoming more software focused, which should lead to increasing margins and higher quality recurring revenues. 

Late in the quarter, the fund increased software exposure with Shopify and Samsara. Shopify is seeing strength in merchants’ gross merchandise value and increasing its generative AI offerings. Samsara is helping industrial companies to digitalise physical assets and offer surface real-time visibility. It continues to scratch its surface of penetration, with new software offerings and asset tags providing large greenfield opportunities and expansion of its addressable market.

Outlook

With so much lack of clarity, it normally pays to be more cautious. However, we believe there are clear ways to generate alpha in equity markets even if the overall direction is unclear.

The Fed commentary surrounding the 50bps cut in September made clear that the economy is strong, yet the rate cut itself might suggest otherwise, so we believe the market is going to remain volatile around data points until the path of the economy is clear. 

While market direction may be hard to predict into year-end, we believe the backdrop is supportive of a broadening out in the market. This should translate into fertile conditions for stock, sector, or theme pickers. Looking at the winning equities ‘baskets’ in Q3, (according to Goldman Sach’s designations), the US is led by housing, non-profitable tech, ‘power up America’ and infrastructure – all lower rate beneficiaries while their AI basket of names turned in a negative quarter.  Technology has been side-lined at its broadest level as the next wave of AI opportunity is more carefully scrutinised.

Our base case remains that set out last quarter: alpha will be generated from a focus on a broadening out of market leadership and less so from betting on the absolute direction of markets. It’s time to think beyond the consensus trades of the last 12 months; this should be highly beneficial for stock-picking strategies.

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

* Source: FE Analytics, as at 30.09.24, total return, net of fees and income reinvested

Key Risks 

Overseas investments may carry a higher currency risk. They are valued by reference to their local currency which may move up or down when compared to the currency of the Fund. This Fund may have a concentrated portfolio, i.e. hold a limited number of investments. If one of these investments falls in value this can have a greater impact on the Fund's value than if it held a larger number of investments. The Fund may encounter liquidity constraints from time to time. The spread between the price you buy and sell shares 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.