Liontrust Sustainable Future Defensive Managed Fund

• Equity markets ended 2024 on a strong note, capping another positive year for risk assets, particularly equities.
• We made several adjustments to asset allocation, reducing cash and gilts, increased corporate bonds (including European bonds), and shifting focus from UK to global equities.
• In terms of single-stock performance, Visa and Spotify were among the top performers following strong earnings releases, while TransMedics and Advanced Drainage Solutions weakened.
• Within fixed income, our long duration position detracted from performance as yields rose significantly over the quarter. Our overweight to corporate bonds added to performance, as credit spreads in sterling investment grade tightened.

The Fund returned 0.7% over the quarter, versus the 0.1% IA Mixed Investment 20-60% Shares sector average (the comparator benchmark)*.

Market review

Equities

Equity markets ended 2024 on a strong note, capping another positive year for risk assets, particularly equities. Despite an economic slowdown driven by the rapid interest rate hikes of 2022 and 2023, corporate earnings have shown resilience. Economic momentum, fuelled by areas like artificial intelligence (AI) investment, has propelled markets forward. However, this has created a global economy marked by uneven growth.

Regions such as China and Europe, along with sectors like construction and industrials, remain sluggish. Recessionary conditions persist in markets sensitive to interest rates or heavily exposed to China's economic challenges. In contrast, investments in AI and data centres have surged, ushering in what many view as a golden age for AI.

From an economic standpoint, inflation has remained stubbornly high. Although 2024 brought the long-anticipated cuts to interest rates, inflationary pressures, especially in the US, continue to persist. Equity markets and the broader US economy appear to have adapted to a "higher for longer" interest rate environment. The post-pandemic era has ushered in a higher cost of capital, which seems likely to remain elevated for the foreseeable future.

The return of Donald Trump to the White House has driven much optimism in equity markets. Policies aimed at reshoring manufacturing may boost US industrial growth, leveraging automation to offset higher labour costs. This aligns with broader reindustrialisation themes, but the degree to which tariffs are implemented will be an important determinant of how the global economy grows and how strong stock market returns are. Will Trump use the threat of broad-brush tariffs as a tool to bring his trading partners to the table and make concessions on the wide-ranging areas he is unhappy with, or will he follow through and do as he has promised?

After a strong year for equity performance, the global economy ended 2024 in a delicate balance after years of extraordinary events. A once-in-a-century pandemic, surging inflation, and aggressive interest rate hikes have shaped a landscape of higher costs and elevated interest rates. Meanwhile, AI’s rapid adoption has driven massive investment, with firms like Nvidia leading the charge in market performance. Although AI promises long-term productivity gains, we believe 2025 will see heavy investment broaden into technologies addressing AI’s energy demands. As we move into the next economic cycle, investment across our economy will broaden beyond that of AI, which we believe should also translate to more balanced leadership from a stock market perspective.

Fixed income

In the first half of the year, UK yields behaved almost in lockstep with their US counterparts, which saw 10-year yields some 70 basis points (bps) higher by the end of June, before a sharp turn lower following a significant weakening of the US labour market in Q3. This proved somewhat short-lived however, and the final quarter of the year saw bonds sell-off aggressively, partly as those fears over the US economy were diminished by the data which followed, and the market digested the US Presidential election result.

Much of the subsequent UK moves were attributable to the budget delivered by Rachel Reeves in late October, where she sailed closer to the wind with her fiscal plans than we, and the market, anticipated. The mix of policies involved greater spending commitments and a substantial increase in employment costs for the private sector, which has pushed up inflation projections for 2025. This is a story which continues to play out and is impacting UK assets as we begin 2025. The near-term could prove quite noisy, with the possibility that the government have to revise its tax and spending plans to allay market concerns. How its responds to the situation will be important for the gilt market’s credibility going forward.

More broadly however, UK economic data has continued to strike a fairly lacklustre tone in our view. Surveys on business confidence, employment prospects and overall sentiment have been quite downbeat, with the prospects of significant increases in employment costs having a sizable impact here. GDP growth has disappointed, with Q3 revised to stagnation at 0.0%, and early indicators for Q4 looking sluggish also. Pay growth figures released in December were firm however, and neatly summarised the issue for the MPC – activity appears to be stalling while inflationary pressure remains. The decision to hold rates in December was largely expected. However, the 6-3 vote split with 3 members advocating for a cut was more dovish than markets had expected. With little in the way of additional colour around the decision given the lack of press conference or accompanying forecasts, we will have to wait until February for a detailed update on the committee’s thinking. 10-year gilt yields rose a little under 60bps over the quarter, to 4.57%.

In something of an odd quirk, the yield on the benchmark 10-year Treasury bond ended 2024 at the same level as its UK counterpart, 4.57%, having risen some 85bps. One can conclude from these relative moves that gilts actually outperformed treasuries over this period, although this could reasonably be described as a ‘least ugly’ contest. As it has done for much of this year, the Treasury market set the broad tone for its developed market peers, and a number of factors combined in pushing yields higher. Firstly, the fears over labour market cracking were calmed by subsequent firmer data, while the re-election of Donald Trump to the presidency alongside a Republican sweep of Congress reinforced expectations of inflationary policies around trade and spending. The Federal Reserve then validated market moves in December, delivering a ‘hawkish cut’, with outright dissent on the Federal Open Market Committee against cutting, increases to the median ‘dot’ which signals expectations for the path of the funds rate, and a change in language to signal greater caution going forward.

The Eurozone was something of an outlier in this quarter, although yields did still rise over the period, with 10-year Bunds around 25bps higher at 2.37%. This outperformance was attributable to further weakness in the growth outlook, and fears over what prospective tariffs from the US might do to already struggling manufacturing sectors in Germany and France. While Q3 growth did actually hold up reasonably better than initial expectations, signals from PMIs and other surveys have suggested concern over the future path of growth. Meanwhile, political volatility in France and Germany has done little to suggest these two important economies will have governments likely to galvanise the bloc’s prospects. The ECB have shown greater confidence in the path of rates being lower, which is to be expected given the concerns over growth and with core inflation somewhat lower than in the UK and US.

Changes to our strategic asset allocation

The Liontrust Sustainable Future Managed Fund range invest across diverse asset classes to deliver superior returns while adhering to their risk ratings. Periodic reviews ensure these funds remain well-positioned for future performance. Recent changes in the investment landscape have prompted adjustments to our strategic asset allocation.

Key considerations include the end of quantitative easing and near-zero interest rate policies, which have shifted the relative attractiveness of cash to favour government and corporate bonds. Additionally, the global equity market, particularly the US, continues to outperform UK equities, with the UK now accounting for less than 4% of the MSCI World Index. Finally, broadening corporate bond exposure to include European issuers enhances access to companies with strong sustainability profiles.

In response, we have made several adjustments. These include reducing the cash allocation, expanding corporate bond exposure to include European bonds, decreasing gilts in favour of corporate bonds, and increasing global equity exposure while slightly reducing UK equities. The most significant shift involves a reduced allocation to gilts, as corporate bonds offer higher potential returns with limited additional risk. Equity exposure has increased by 5%, emphasising global equities outside the UK.

Equity performance

Both the global equity and UK equity portfolios delivered outperformance over the peer group, which drove strong Fund performance.

From a global equity perspective, performance for the overall market was once again driven by mega-cap technology stocks, which continued to dominate investor sentiment. Among these, Tesla – a stock we do not hold within the Fund – stood out as the best performer overall. This rally was further fuelled by anticipated winners emerging from policy shifts expected under the incoming Trump administration, which lent additional momentum to a narrow section of the market. Our thematic process is quite broad, straddling 22 investment themes, and many of these themes benefited from this Trump rally. Areas related to themes such as Improving the Management of Water and Delivering a circular materials economy benefitted, reflecting their crucial role in the potential rebuild of the American industrial heartland.

The Fund’s top performer within the global equity portfolio was digital payments specialist Visa (+23%), after the company delivered robust financial performance with net income of $5.3 billion, up 14% year-on-year and revenue growth of 12% reaching $9.6 billion. In addition Visa continued to benefit throughout the quarter from a favourable regulatory environment following the Republican party's US election victory and an ongoing rate-cutting cycle, which is reviving capital markets and strengthening consumer confidence.

Spotify (+30%), the world’s dominant audio platform, once again managed to exceed investor expectations with its latest quarterly results. Paying subscribers have now risen to 252 million, ahead of consensus analyst forecasts of 250 million, while gross margins were also better than expected, widening to over 31% after cost cutting efforts.

While Spotify primarily fits into our Encouraging sustainable leisure theme, it also contributes to reducing energy consumption and pollution when compared to records and discs which used energy intensive hydrocarbon derived plastics and cause pollution issues at end of life.

Another notable performer was leading human capital management (HCM) software provider Paylocity (+29%) after reporting total revenue of $363 million, up 14% year-over-year. For FY2025, Paylocity expects total revenue between $1.535 and $1.55 billion, representing approximately 10% growth.

Held under our Enabling SMEs theme, Paylocity contributes to a sustainable economy by ensuring businesses can pay their employees on time, and can accurately collect taxes.

Among the detractors, US medical device company TransMedics (-57%) experienced a significant decline primarily due to disappointing third quarter financial results, with revenues of $109 million, up 64% year over year but still falling short of expectations. The shortfall was attributed to a national decline in transplant volumes and reduced service component charges, which impacted margins and overall financial performance. Furthermore, the company's aviation operations faced challenges with unscheduled maintenance, reducing the number of operational aircraft and causing missed revenue opportunities.

We remain confident in the underlying business fundamentals of TransMedics, despite the company’s volatile nature. Given its potential for sharp price swings, it is essential to evaluate this investment with a long-term perspective, focusing on a five-year horizon to fully capture its growth potential and value creation.

Advanced Drainage Systems (-21%) saw weaker demand from non-residential markets in its latest quarter, which led it to trim full-year financial targets. While the company has dealt with tepid end markets for the last year or two, any government impetus to revitalise industrial America could spark an inflection for end market demand. A holding in our Improving the Management of Water theme, Advanced Drainage Systems is focused on developing solutions for water management, while keeping plastic out of landfills. Its products keep waterways safe from pollution and prevent excessive stormwater runoff. 

As a critical enabler for new construction, Advanced Drainage Systems’ products are foundational to reshoring efforts. While recent market conditions have been challenging, a shift in US industrial policy under the incoming administration could catalyse growth for this essential player.

Despite posting reported solid Q2 2024 results, shares in TopBuild (-18%), the US installer and distributor of insulation products, fell after it revised 2024 guidance downward. Exposed to our Improving the efficiency of energy use theme, TopBuild now forecasts 2024 sales of $5.3 billion to $5.5 billion, assuming mid-single digit residential growth and low single digit commercial/industrial growth for the year, while noting that the revision largely reflects timing of demand, rather than any underlying changes in the business.

Though the US housing market faces challenges, long-term drivers like undersupply and demographic demand remain strong. Companies like TopBuild are set to benefit from improving residential activity and a focus on energy-efficient solutions. As cyclical pressures ease, we believe TopBuild is likely to benefit from the gradual rebound, underscoring the sector's enduring potential for investors.

Within the UK equity portfolio, the final quarter of 2024 was a strong one in terms of relative performance, concluding a good year. We have long felt that the share prices of the high-quality companies that we back – with their alignment with strong sustainability trends – have been depressed. This year saw some of that promise being recognised. However, we believe there is still a long way to go for the businesses in our portfolio, and so look forward to 2025 building on the past year.

Transfer platform Wise (+58%) upgraded its full-year income growth guidance from 28% - 33% to 33% - 38%. Wise is held under our Transparency in financial markets theme and its mission is to bring transparency and fairness to into moving money around the world. This covers pricing of products and sharing the economies of scale. Our conviction is reinforced by recent news that Morgan Stanley and Standard Chartered will be using the Wise platform for their own FX proposition.

Trainline (+31%), which is held under our Making transport more efficient or safer theme, raised its growth targets for the third time this year. The company now forecasts full-year net ticket sales growth of 12-14%, up from 8-12%, and revenue growth of 11-13%, up from 7-11%. Trainline explained that its strong performance is driven by a number of factors, including increased demand for rail travel, the continued rollout of its digital platform, and the benefits of operating leverage as it scales.

Sage Group (+24%) was also among the top performers, most notably announcing a £400 million share buyback, while also reporting strong sales in its Cloud business which boosted annual revenue. The company provides financial, HR and payroll software for small and medium-sized enterprises and is held under our Enabling SMEs theme.

Infrastructure performance

The Infrastructure portfolio struggled over the quarter, as higher bond yields again put pressure on the asset class.

The weakest performer was Foresight Environmental Infrastructure Fund, which struggled on the back of pressure on valuations on the asset class, combined with the fact that one of its investments had to be written down. The investment in a Green Hydrogen developer in Germany led to a write down in NAV of -2.6%, despite the majority of its portfolio continuing to deliver strong results.

Fixed income performance

Within fixed income, our long duration position detracted from performance as yields rose significantly over the quarter. Our overweight to corporate bonds added to performance, as credit spreads in sterling investment grade tightened by 23bps despite those rising yields.

The Fund benefitted from its holding in Annington Funding, following its agreed sale of its Married Quarters Estate back to the Ministry of Defence. Annington subsequently announced a buyback for its outstanding bond issues, at an attractive uplift from their pre-announced levels.

We retain a constructive view on the outlook for corporate credit, though we are cognisant that spreads have tightened materially over the past year. While some fundamental metrics have normalised back towards long-term averages, balance sheets remain robust. Meanwhile, there remains significant technical support in markets which have seen relatively limited issuance and healthy demand from end investors.

We also maintain our overweight duration position, which we believe will benefit performance in the coming year, as markets reevaluate the monetary policy outlook for the UK amid disappointing economic growth and a weakening labour market.

Trade activity

We initiated a position in Advantest under our Better monitoring of supply chains and quality control theme. Advantest provides equipment that tests semiconductors for defects, ensuring that electrical components meet strict safety requirements in markets such as autos, as well as reducing waste in the semiconductor fabrication process.

We also initiated a position in Berkeley Group, the builder of homes in London and the Southeast, under our Building better cities theme. Berkeley are specialists in urban regeneration and in providing high quality energy efficient houses, and have ambitious targets for improving resource efficiency and lowering greenhouse gas emissions in the construction and use of its homes.

We added Oxford Instruments, the provider of high technology products and services to the world’s leading industrial companies and scientific research communities. Held under our Better monitoring of supply chains and quality control theme, the company has a world class ability to image, analyse, and manipulate materials down to the atomic and molecular level. This enables fabrication and characterisation at an atomic level, as well as helping research and discovery through analysis and imaging.

We sold our position in Infineon Technologies, the German producer of efficient power management chips. We have concerns around competition and pricing pressure in its auto businesses, particularly in China, which is becoming increasingly crucial in the growth in electric vehicle  production. The Connected Secure Systems and Power & Sensor Systems businesses have been ex-growth now for a few years, and if autos also begins to slow, the investment becomes increasingly risky as the company has limited exposure to the significant growth occurring in the semiconductor industry, which is now heavily focused on advancements in AI.

We exited the position in Spectris, having initiated a small position in this company in November 2023. We felt the prospects would be good for the analytical equipment it sold. However, the company proved to be less predictable on revenues where the life science end market was particularly weak and on leverage where three acquisitions had brought net debt-to-EBITDA to above 2x. This led to us exiting the position and investing the proceeds in existing holdings: Sage and Spirax, both of which we have higher confidence in.

We made the decision to exit Rentokil after a trading update in September where it downgraded its growth expectations for 2024 and cited some issues with integrating the Terminix acquisition. Our original thesis was that Rentokil’s management has a track record of integrating acquisitions well and delivering strong employee and customer retention that Terminix required. However, despite some improvement in these KPIs, the business has been underperforming prior to the commencement of some of the more complex stages of the integration process – something we had not anticipated to happen as soon. We feel that management have lost credibility given numerous assertions made over the past year  and we have therefore lost confidence in their ability to execute a turnaround in the US pest control business.

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

*Source: FE Analytics, as at 31.12.24, total return, net of fees and income & interest reinvested.

**Source: FE Analytics, as at 31.12.24, primary share class, total return, net of fees and income & interest reinvested.

KEY RISKS

Past performance does not predict future returns. You may get back less than you originally invested.

We recommend this fund is held long term (minimum period of 5 years). We recommend that you hold this fund as part of a diversified portfolio of investments

• All investments will be expected to conform to our social and environmental criteria.
• 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.
• Bonds are affected by changes in interest rates and their value and the income they generate can rise or fall as a result;
• The creditworthiness of a bond issuer may also affect that bond's value. Bonds that produce a higher level of income usually also carry greater risk as such bond issuers may have difficulty in paying their debts. The value of a bond would be significantly affected if the issuer either refused to pay or was unable to pay.
• 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.

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.

DISCLAIMER

This material is issued by Liontrust Investment Partners LLP (2 Savoy Court, London WC2R 0EZ), authorised and regulated in the UK by the Financial Conduct Authority (FRN 518552) to undertake regulated investment business.

It 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.

This information and analysis is believed to be accurate at the time of publication, but is subject to change without notice. Whilst care has been taken in compiling the content, no representation or warranty is given, whether express or implied, by Liontrust as to its accuracy or completeness, including for external sources (which may have been used) which have not been verified.

This is a marketing communication. Before making an investment, you should read the relevant Prospectus and the Key Investor Information Document (KIID) and/or PRIIP/KID, 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. 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.