Liontrust UK Smaller Companies 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 33% to their long-term average.
• The portfolio is expected to deliver around 10% earnings growth next year, with a healthy dividend yield of 3%.

The Liontrust UK Smaller Companies Fund returned -0.3%* in 2024. The FTSE Small Cap (excluding investment trusts) Index comparator benchmark returned 13.8% and 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 by 7.0% and 12.3% respectively. The Fund was tracking the market and sector relatively closely until late May with the divergence largely playing out post the announcement of the general election.

2024 – fund performance versus the index and sector

Source: FE Analytics, as at 31.12.24, primary share class, 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 (69% at 31 December 2024) was costly to performance during the year. The FTSE AIM All Share total of -4.0% compared to the FTSE Small Cap ex investment companies 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 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 several 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
• Stocks – several of the larger AIM stocks (some which we owned – see below) downgraded expectations

Stock specific

Four key detractors each reduced performance by more than 70bps, with the cost compounded by significant de-rating in valuations. One was very cyclical in nature: Focusrite (-102bps) and three were a combination of cyclical and company specific issues: YouGov (-181bps); Impax (-110bps) and Next 15 (-87bps). The average de-rating across these five companies was particularly harsh at 37%. We retain all four of these positions and consider the recovery potential to be significant when the cyclical headwinds subside.

Looking beyond the four detractors noted above, the portfolio as a whole performed relatively resiliently during the year with the majority of holdings delivering earnings either ahead or in line with expectations. There were notable strong positive contributions to performance from portfolio holdings such as Cohort, On The Beach, AJ Bell, Alfa Financial, Tatton Asset Management and Alpha Group, which collectively added ~6.5%.

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 ~10% earnings growth for the year ahead. Whilst this is modestly below the long run average for the fund, in the context of an uncertain macro backdrop, we feel it is attractive and represents further recovery potential as cyclical headwinds subside.

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

Valuations are attractive with the aggregate forward price/earnings ratio of 14x, representing a discount of nearly 33% to the long run average P/E of 21x for the Fund. A free cash flow yield of 8% is particularly compelling and is at levels not seen for a very long time in the Fund’s history (~2 standard deviations above the long run average free cash flow yield of 4.6%).

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 earnings growth of 10%, 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, nearly 90% of the portfolio is trading at a discount to long run averages. The average stock is on a 28% 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

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

*Source: Financial Express, as at 31.01.25, 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, primary class.

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.

• 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. 

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.