Liontrust UK Smaller Companies Fund

• Retention of 50% IHT relief on AIM shares is a better-than-feared outcome, allowing investors to re-focus on significant undervaluation of many small cap shares. 
• Mortgage Advice Bureau rallies strongly within AIM bounce, without issuing any investor update.
• The position in iomart was sold during the month. 

The Liontrust UK Smaller Companies Fund returned -0.1%* in October. The FTSE Small Cap (excluding investment trusts) Index comparator benchmark returned -1.0% and the average return of funds in the IA UK Smaller Companies sector, also a comparator benchmark, was -0.7%.

Global equity markets fell in October as the prospect of the approaching US election, weaker-than-expected earnings from US tech titans and ongoing geopolitical instability in the Middle East contributed to a risk-off environment.

In the UK, investors had to contend with an additional source of uncertainty in the form of the Autumn Budget. Ahead of the Budget, speculation had been rife over potential changes to the investment landscape, including the capital gains tax rate and inheritance tax (IHT) status of AIM-listed shares. This contributed to a substantial degree of nervousness from investors in the weeks running up to the announcement, which was most pronounced for the AIM market.

We were therefore relieved that the Chancellor did not fully remove IHT relief from AIM shares, which was what the market had priced in, but rather introduced a 50% relief. By retaining some relief, the government recognises the vital role played by the AIM market in the UK’s economic growth.

Equally important is that the policy uncertainty that has been hanging over AIM for several weeks (and years) has now been put to bed. With the IHT removal risk now crystalised with a better-than-feared scenario, AIM shareholders and UK investors more broadly can look forward more confidently, focusing on company fundamentals. UK equities continue to trade at a substantial discount to their intrinsic value, particularly at the smaller end market cap scale. This investment opportunity is based on company fundamentals, rather than any preferential tax treatment, and we remain confident that the high-quality companies our funds seek out will ultimately re-rate to close this valuation anomaly.

Several of the portfolio’s AIM stocks rallied towards the end of month following the Budget, but this cohort still lags substantially behind the FTSE Small Cap and FTSE All-Share indexes year to date, and we would expect this gap to narrow in the coming months.

Within this AIM bounce, one of last month’s largest portfolio detractors – Mortgage Advice Bureau (+27%) – rallied strongly without issuing any investor update.

Elsewhere amid the risers, Netcall (+13%) reported solid growth in the year to 30 June 2024 and commented that sales momentum has carried over into the new financial year. The customer engagement software group grew revenue 9% to £39 million, with recurring cloud services revenues rising 19% to £20 million.

Although Robert Walters’ (+14%) Q3 trading update maintained its prior assessment of a hiring market slowdown that is unlikely to improve until 2025, shares in the company rallied. Year-to-date revenues have fallen 12% in constant currency terms as client and candidate confidence remains subdued. Despite this, it is confident of protecting profitability this year after headcount was reduced by 17%. 

The tone was less positive at Kainos Group (-13%), which lowered financial guidance for the second time in the space of eight weeks. The outsourced provider of IT design and support services has experienced weaker demand, which it attributes to delays in client decision making due to the macro-economic environment. On 2 September, Kainos forecast revenues for the year 31 March 2025 to grow more slowly than it had hoped, but with profits still on track to meet expectations. At the end of October, it said revenues would fall “moderately” short of this guidance, with a knock-on impact on profit.

Specialist on-trade audio-visual equipment distributor Midwich Group (-12%) has also painted a picture of tough market conditions in its investor updates this year. While at the interim results in July it maintained full-year adjusted operating profit targets – relying on cost cutting and a return to growth in the second half of the year – it has now been forced to cut guidance. While the UK market has stabilised and North America remains strong, market conditions elsewhere remain weak, particularly in Germany.

Brooks Macdonald Group (-12%) came under pressure as its quarterly update on funds under management showed a £127 million net outflow, although positive investment performance ensured total assets grew in the three months to 30 September. The company blamed uncertainty around the Autumn Budget for impacting investor confidence, leading to lower gross inflows.

The indicative 54p-a-share takeover approach received by Eckoh (+14%) in August converted to a firm offer which its Board recommended in October. Private equity group Bridgepoint will acquire the provider of secure payment products and customer contact solutions, subject to a shareholder vote, with completion scheduled for Q1 2025.

The Fund’s position in cloud computing infrastructure and IT managed services provider iomart was sold during the month. In recent years the managers have become increasingly concerned over the strength of the company’s competitive advantage, as the dominance of hyperscale cloud providers has grown and businesses have increasingly turned to public cloud solutions. For iomart, which owns its own data centres and specialises in private and hybrid cloud provision, organic growth and operating profit margins have trended down and put significant pressure on cash flow returns on capital. Although the company has committed to reshaping its offering, hoping to grow higher margin, faster growing areas of managed service provision such as data and cyber security, we believe the risk of effecting such a transition in the glare of the public markets outweighs the potential reward and have taken the decision to exit the position. 

Positive contributors included:

Mortgage Advice Bureau (+27%), Eckoh (+14%), Robert Walters (+14%), Netcall (+13%) and Microlise (+12%).

Negative contributors included:

Team17 Group (-17%), Kainos Group (-13%), Midwich Group (-12%), Brooks Macdonald Group (-12%) and Foresight Group (-11%).

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

*Source: Financial Express, as at 31.10.24, 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.

DISCLAIMER

This is a marketing communication. Before making an investment, you should read the relevant Prospectus and the Key Investor Information Document (KIID), which provide full product details including investment charges and risks. These documents can be obtained, free of charge, from www.liontrust.co.uk or direct from Liontrust. Always research your own investments. If you are not a professional investor please consult a regulated financial adviser regarding the suitability of such an investment for you and your personal circumstances.

This should not be construed as advice for investment in any product or security mentioned, an offer to buy or sell units/shares of Funds mentioned, or a solicitation to purchase securities in any company or investment product. Examples of stocks are provided for general information only to demonstrate our investment philosophy. The investment being promoted is for units in a fund, not directly in the underlying assets. It contains information and analysis that is believed to be accurate at the time of publication, but is subject to change without notice.