Liontrust UK Micro Cap Fund

• The second half of 2024 was challenging for the Fund due the headwind from its overweight position in small cap growth, particularly in AIM stocks.
• The outlook is positive, with the Fund’s quality metrics at normal levels but valuations at a discount of around 16% to their long-term average.
• The portfolio is expected to deliver around 17% earnings growth next year, with a healthy dividend yield of 3%.

The Liontrust UK Micro Cap Fund returned 0.0%* in 2024. The FTSE Small Cap (excluding investment trusts) Index and the FTSE AIM All-Share Index comparator benchmarks returned 13.8% and -4.0% respectively. The average return of funds in the IA UK Smaller Companies sector, also a comparator benchmark, was 6.7%.

It was a challenging period of performance, with the Fund underperforming the IA sector and FTSE Small Cap ex investment companies index by 6.2% and 12.1% respectively, but outperforming the FTSE AIM All Share by 4.1%. The Fund was tracking the sector relatively closely until September with the divergence largely developing on the run up to the Autumn Budget when AIM stocks were under particular pressure.

2024 – fund performance versus the index and sector 

 
Source: FE Analytics, as at 31.12.24, bid-to-bid, net of fees, income reinvested, total return. Past performance does not predict future returns.

We attribute the underperformance to two main factors:

• Overweight position in small cap growth, AIM in particular (and underweight “value”)
• Stock specific  

Taking each in turn:

Overweight position in small cap growth, AIM in particular

The longstanding significant weight in AIM, which comprises most of the portfolio, was costly to performance during the year. The FTSE AIM All Share total return of -4.0% compared to the FTSE Small Cap (ex-IC) total return  of 13.8%, an underperformance of 15.6%. As a reminder, the investment process naturally tilts the investable universe towards the quality and growth style factors and away from the value factor. Furthermore, the requirement of management ownership as part of the process determines that the investable universe is more weighted towards AIM stocks than FTSE Small Cap.

The underperformance of AIM can be attributed to a number of factors: 

• Style – it is a more “growth” orientated index than the FTSE Small Cap ex Investment Companies, which is more tilted to “value” (P/E ratios at 1st January 2024 were 19x and 10x respectively) 
• Political – particularly speculation of tax relief applied to AIM shares

Stock specific

It was a challenging period for micro cap companies with many facing higher costs and reduced demand for their products resulting in a squeeze on profitability. The investment impact was compounded by the apathy towards UK small-cap stocks, particularly those listed on AIM, which resulted in significant compression to valuations in many cases.

There were three notably significant detractors during the year (each reduced performance by more than 100bps): Churchill China (-151 bps); James Cropper (-124 bps) and Solid State (-111 bps). Churchill China is in the midst of a cyclical downturn for its high quality ceramic products and, whilst market share gains are encouraging, market volumes are down significantly.  Similarly, James Cropper faces a number of cyclical headwinds to demand for its high quality paper and advanced materials products, which combined with higher energy costs has reduced profitability. Turnover of senior executives within the business has also been unhelpful, however, we are encouraged by the quality of the recent CEO and CFO hires. Finally, Solid State for the most part had a successful year but was impacted by a late postponement to a significant order bound for the UK armed forces because of delayed decision making by the new Government as part of the strategic defence review. Whilst the timing slippage of this contract is material in the context of market forecasts, we are hopeful that the order is delayed rather than cancelled and therefore should contribute to a future period.  We retain all three of these positions and consider the recovery potential to be significant when the cyclical headwinds subside.

Looking beyond the three detractors noted above, there were notable strong positive attribution effects from portfolio holdings such as Beeks Financial Cloud, Intercede, On The Beach, Eckoh, Cohort and Kitwave, which collectively added 7.7% to Fund performance during the year.

Outlook

We are cautiously optimistic about the outlook despite a relatively uncertain macro-economic backdrop. The portfolio is, at the aggregate level, delivering healthy levels of growth, an attractive dividend yield and supported by quality fundamentals.

As at the end of December, based on market consensus, the portfolio is expected to deliver ~17% earnings growth for the year ahead, which is attractive in the context of an uncertain macro-economic backdrop.

The Fund’s quality metrics are broadly in line with long run averages across most measures.

Valuations are attractive with the aggregate forward price/earnings ratio of 16x representing a discount of 16% to the long run average P/E of 19x for the Fund. A free cash flow yield of 8% is particularly compelling (~2 standard deviations above the long run average free cash flow yield of 5%).

Portfolio free cash flow yield 

 
Source: Style Analytics, monthly data points to 31 December 2024. Past performance does not predict future returns.

In addition to the 17% expected earnings growth, investment returns for the year ahead are set to be supported by a healthy dividend yield of 3% 

Portfolio valuations versus 10-year averages

Source: Style Analytics, monthly data points to 31 December 2024. Past performance does not predict future returns.

Looking at valuations at the stock level, over 80% of the portfolio is trading at a discount to long run averages. The average stock is at a 20% discount – this represents significant reversion potential if sentiment towards UK equities supports a re-rating back to long run averages, which we are increasingly hopefully that policy changes will help to catalyse.

Portfolio forward price/earnings ratio versus 10-year averages

 
Source: Bloomberg, 13.01.25. Data excludes loss making companies and companies where 12m forward EPS forecast data is unavailable. Long term average = 10 year average for each of the underlying stocks in the fund. % premium/discount is calculated by dividing the current blended 12m forward P/E ratio by the 10 year average for each stock. Past performance does not predict future returns.

*Source: Financial Express, as at 31.12.24, total return (net of fees and income reinvested), bid-to-bid, institutional class. **Source: Financial Express, as at 31.12.24, total return (net of fees and income reinvested), bid-to-bid, institutional class. 

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

*Source: Financial Express, as at 31.12.24, total return (net of fees and income reinvested), bid-to-bid, institutional class. **Source: Financial Express, as at 31.12.24, total return (net of fees and income reinvested), bid-to-bid, institutional class.

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.

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.

• 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 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.