Liontrust Sustainable Future European Growth Fund

• We believe recent headwinds will soon abate, with fundamentals such as pricing power, earnings growth and balance sheet strength weighed more accurately by the market.
• Notable performers over the quarter included Wise, PUMA and 3i Group, while Kingspan and Novo Nordisk were among the detractors.
• We initiated portfolio positions in Novo Nordisk and Inficon, and sold positions in Lonza and Stevanato.

The Fund returned -2.3% over the quarter, compared with the -4.2% return from the MSCI Europe ex-UK Index and the -4.0% IA Europe ex-UK sector average (both of which are comparator benchmarks)*.

While strong relative performance was sustained over the second half of the year, the Fund underperformed for the year as a whole, driven by a negative second quarter related to a sell-off in the higher growth part of the market. The Fund ended the year 0.6% behind the benchmark but returned an absolute 1.3%.

Given the valuation of the portfolio as a whole, with the average company trading at a c.20% discount to its five year average price to earnings ratio, we believe the Fund is well positioned to deliver strong performance in the coming years.

Our long-term, sustainability driven, process focuses on high quality companies with superior returns on capital, growth and balance sheets to weather potential economic turbulence. This high quality form of investing has been out of vogue with the market since interest rates started to rise in 2022. This higher cost of capital environment has also presented a headwind to smaller market capitalisation companies, with the perception that these businesses are riskier.

We believe these twin headwinds will eventually abate, with fundamentals such as pricing power, earnings growth and balance sheet strength assessed more accurately by the market.

Turning to company specifics, earnings releases were responsible for some of the larger share price moves within the portfolio in Q4.

Within the gainers, one of the Fund’s top performers was German sportswear company PUMA (+18%), which reported a robust 5% increase in currency-adjusted sales for Q3, reaching €2.31 billion. This growth was broad-based, spanning key regions, including the Americas, Asia/Pacific, Europe, and the Middle East and Africa, highlighting the brand's global appeal and resilience in the face of challenging economic conditions. The Americas spearheaded this growth with an impressive 11.4% increase, driving regional sales to €872 million. This performance was underpinned by strong demand in the United States and Latin America.

Held under our Enabling healthier lifestyles theme, around a third of PUMA’s sales are derived from active sportswear, which enable people to take part sports, increase activity and tackle obesity.

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 resource efficiency as it has effectively dematerialised much of the physical consumption used to listen to music such as CD players or vinyl.

Despite a lack of significant news in Q4, Trustpilot (+36%) emerged as one of the top-performing stocks during the period. This strong performance was further bolstered by an analyst initiating coverage on Trustpilot shares with a "Buy" rating, signalling confidence in the company's growth prospects. Held under our Connecting people theme, Trustpilot is an independent digital review platform for consumer reviews and insights. It was founded to address the ‘trust gap’ on the internet; its mission is to improve trust by connecting consumers and businesses and enabling independent communication to help them help each other; consumers can shop with confidence and businesses gather rich insights to help them improve their offering.

Turning to the detractors, shares of Danish pharmaceutical company Novo Nordisk (-22%) – a new holding in the Fund known for its blockbuster drugs Ozempic and Wegovy – dropped sharply following the release of clinical trial results for its next generation obesity treatment, CagriSema. The late-stage study revealed that CagriSema enabled patients to lose an average of 22.7% of their body weight, falling short of the trial’s target of a 25% average weight loss. While the results of the trial disappointed the market, it remains the most successful weight loss trial ever. This is despite a more flexible trial protocol where participants were not forced to titrate to the highest dosage of the drug.

Added under our Enabling innovation in healthcare theme, Novo Nordisk, once the pioneer of insulin over the past century, has now developed a novel treatment for obesity called Semaglutides belonging to a class of medications known as glucagon-like peptide-1 (GLP-1) receptor agonists. These drugs replicate one of the hormones the gut secretes when we eat which helps us to feel full, helping reduce obesity and comorbidities such as Type 2 diabetes, heart disease, renal disease, vascular dementia, stroke and blindness. We believe that, despite the market noise, the company will continue to grow strongly and iterate on its new class of obesity drugs, just as they did for over a century with insulin.

Shares in Kingspan (-17%) slid in November after the company suggested soft recent demand could lead 2024 revenues to be at roughly similar levels to last year. However, Kingspan commented that next year’s sales should benefit from a high level of order backlog. Kingspan is held under the theme of Improving the efficiency of energy use. Its products will help to decarbonise our economies by reducing the energy required to keep our buildings at the correct temperatures. 85% of its products provide superior insulation – up to twice as effective as mineral fibre.

While there appears to be some signs of market softening, we believe that the long-term drivers of demand for energy efficient insulation and buildings products remains firmly intact.

Renewable energy was one of the main industries whose prospects were viewed as suffering from Trump’s re-election, with related stocks dropping on the day of the result. For Vestas Wind Systems (-34%), the weakness was accentuated by the release of Q3 results which guided towards the low end of its full-year forecasts range for profits.

From our perspective, the urgent need to decarbonise our economy remains as important as ever, and despite some pushback in political circles, it is reassuring that virtually all the technology we need to decarbonise is in place. We continue to expect strong long-term investment returns from companies which allow us to decarbonise, such as renewable energy and technologies which drive energy efficiency.

In terms of trade activity, we initiated a position in Inficon, the global leader in gas analysis, measurement, and control instruments, as well as smart manufacturing solutions. Added to our Better monitoring of supply chains and quality control theme, Inficon’s equipment helps to prevent and identify defects in manufacturing, as well as increasing resource efficiency by reducing energy consumption and detecting leaks. The company is also involved in leading scientific research such as CERN (the Large Hadron Collider) and NASA.

We sold Lonza in the final quarter following a significant rebound in share price from 2023. This sale funded a new position in Novo Nordisk which had fallen dramatically in valuation and which we believe offers greater risk adjusted upside over the long-term.

Revenue growth has always been strong at Lonza. However, the capital intensity of the business left us with questions regarding long-term returns on capital that the business could achieve. We were also concerned over the significant amounts of management turnover with numerous CEOs, CFOs and Board Members during our five-year ownership period.

We also exited the position in Stevanato following a significant deterioration in accounting quality and governance. Firstly, it is extremely uncommon for us buy and sell a company in the same year – however when facts change, we must act to protect client capital.

The original thesis was that Stevanato is strongly linked to our biologic delivery thematic. Stevanato is one of the four companies able to make the important, highly regulated and fast-growing delivery mechanism for biologic drugs such as syringes and vials.

The industry is currently going through an aggressive post-Covid destocking that is impacting the whole group – West, Gerresheimer, Schott and Stevanato. This is something we are aware of and would be happy to wait out with an inevitable return to strong structural growth.

However, we were concerned about the abrupt change of CEO to the son of founder, a significant increase in aggressive earnings management including adjustments to the useful life of assets and an increase in R&D capitalisation – all of which is designed to flatter the profitability of the company at a time of poor cash generation.

We prefer that companies are straight with us regarding their accounting and economic position and we have a suspicion that company is attempting to obfuscate the true situation.