Liontrust GF UK Growth Fund

• Ongoing macroeconomic and geopolitical uncertainty fuels investor risk aversion and weak sentiment towards mid and small caps.
• BAE Systems leads the Fund’s risers – supported by transformation in outlook for the European defence sector – followed by defensive large-cap names
• Many high quality but out-of-favour businesses – particularly in the small cap space – now trade at extreme low valuations, representing a latent source of pent-up value which will be released when sentiment turns.

The Liontrust GF UK Growth Fund returned 0.3%* in Q1. The Fund’s comparator benchmark, the FTSE All-Share, returned 4.5%.

Mounting geopolitical instability and uncertainty over US trade tariffs defined the market environment in Q1.

President Trump’s approach to the Ukrainian conflict included calling for a swift end to the war, criticising President Zelensky and indicating an unwillingness to continue financial and military assistance. As a result, investors factored in higher expectations of military spending in Europe from governments attempting to fill the void and deter Russian aggression – leading to a sharp rally in defence sector stocks.

At the same time, investors struggled to price in the impact of Trump’s trade tariff threats. While it initially seemed that the threatened levies could be negotiating tools to win concessions from trade partners, Trump showed little sign of backtracking ahead of his promise of a further batch of reciprocal tariffs in early April – prompting significant investor nervousness.

In this environment, large-caps and defensive areas held up best. Beneath the FTSE All-Share’s solid quarterly gain is substantial variation in returns to different size segments. While the FTSE 100 was up 6.1%, both the FTSE 250 and FTSE AIM All-Share lost around 5%.

Due to the Fund’s long-term high-conviction overweight position in mid and small cap stocks versus the FTSE All Share Index, this trend was a drag on relative performance.

As the managers have stated on a number of occasions, this underperformance of mid and small caps – driven itself by risk aversion stemming from macro events – has opened an opportunity to invest in these companies at generational valuation lows.

The portfolio also exhibits a strong bias towards the quality style factor as a result of the investment process, which targets companies with enduring competitive advantage stemming from intangible asset strengths, resulting in high cash flow returns on capital. However, value style characteristics outperformed quality and growth in the quarter: the MSCI UK Value Index rose 7.5% and the MSCI UK Growth Index returned 5.0%, compared with the MSCI UK Quality Index’s 2.9% return. 

Within the traditional value sectors, banks extended their run of very strong performance, a trend worth highlighting given the portfolio has zero exposure to the sector. The FTSE All Share banks sub-sector delivered a gain of 16%. The managers remain convinced of the view that banking stocks – with their high business model exposure to factors such as interest rates, which are beyond their direct control, as well as substantial regulatory pressures and competitive threats from innovative fintech start-ups – are unattractive compounders of capital over the long run.

While recent market trends have been tough for relative portfolio performance, there is mounting potential for outperformance from some of the more unloved areas of the market as and when sentiment recovers and valuations revert towards long-term averages.

Over the quarter, the Fund’s top riser was BAE Systems (+36%) – one of the Fund’s largest relative overweights against the index - rallying alongside global defence peers. Other defensive names were prominent in the quarter’s most resilient holdings: global pharma groups AstraZeneca (+9.1%) and GSK (+9.8%); energy giants Shell (+15%) and BP (+13%); and British American Tobacco (+9.9%).

Newsflow among this cohort of stocks was also largely supportive. For example, AstraZeneca recorded 25% constant currency growth in Q4 sales to take its 2024 total to over $ 54 billion – up by 21%. The performance was ahead of consensus expectations, driven by a 41% expansion in oncology sales. For 2025, AstraZeneca expects a high single-digit percentage increase in revenues, with earnings per share rising by a low double-digit percentage.

Shell saw a positive investor response to its new strategic goals unveiled at a capital markets day. While the energy giant will look to generate growth through a focus on its liquified natural gas division – seeking 3% to 5% annual growth through to 2030 – it is also stepping up its focus on cost control, lowering capex and raising its structural cost cutting targets. As a result, it expects free cash flow to rise at over 10% a year through to 2030. Shell also announced that a greater proportion of cash flow will be returned to shareholders via share buybacks and dividends – 40% to 50% of cash flow from operations, up from 30% to 40% previously. 

Elsewhere, Smiths Group (+12%), the diversified engineering business, announced plans to streamline its operations by concentrating on high-performance industrial technologies while divesting non-core business units. The decision, which came shortly after the publication of an activist shareholder letter calling for a reconsideration of group structure, will see the company retain and expand its John Crane and Flex-Tek divisions, which specialise in industrial flow and heat management technologies and represent approximately three quarters of group profits. As part of the restructuring, Smiths Interconnect, a producer of broadband and antenna components, is set to be sold by the end of 2025. Following this, Smiths Detection, known for its airport X-ray screening systems, will either be sold or spun off through a UK demerger.

Alongside these divestitures, Smiths is enhancing its share buyback program to £500 million, with £150 million scheduled for completion by March 2025 and the remaining £350 million by the end of the year.

Indivior (-29%) has also found itself targeted by activist investors. Oaktree Capital Management has prompted a strategic refocusing around Indivior’s core opioid use disorder (OUD) products and pipeline assets, as well as significant board and executive management change. 2024 results announced in February were ahead of previously downgraded consensus expectations but nevertheless included extremely cautious guidance for the current financial year, potentially heralding a welcome change in the company’s approach to forecasting.

Intellectual property support services provider RWS Holdings (-31%) gave back last quarter’s gains. Following a tough 2024, RWS has been confident in its ability to integrate AI into its portfolio of services, and full-year results show these products contributing to a return to growth in the second half of the year. Organic constant currency (OCC) revenue growth in the second six months was 2%, resulting in a flat performance for the year as a whole. Within this, around 25% of revenue came from AI-related services such as TrainAI and Language Weaver, a category which grew at 7% in OCC terms over the year.

Technology and data-driven growth consultancy specialist Next 15 (-27%) announced that it expected profits for the fiscal year ending 31 January 2025 to be at the lower end of analyst expectations, although new business wins had shown an encouraging uptick in the second half. The company also took steps to rebuild confidence in the equity story after the loss of a large contract last year. It announced the departure of the chief financial officer, a restructuring drive which aims to deliver annualised cost savings of £40 million, as well as selective increases in investment in AI products and services.

Renishaw (-24%) commented in February’s half-year results that order intake has recently improved, but investors focused instead on a deterioration in quarterly sales. A slowdown in its second quarter meant that six-monthly sales rose only 3% year-on-year to £341 million, with profit before tax rising 2% to £57.5 million – both below expectations. While the specialist in high-tech precision engineering for metrology and healthcare says it has seen improved order trends, particularly from semiconductor and consumer electronics customers, its 2025 guidance also fell short of investor expectations.

Gamma Communications (-21%), the provider of cloud-based enterprise communications, announced a €165 million cash acquisition of Starface, a company specialising in proprietary business communication and collaboration software for small and medium-sized enterprises (SMEs) in Germany. Starface boasts a nationwide distribution network with over 2,000 channel partners, which Gamma intends to leverage to expand its SME presence in this key market. Additionally, Gamma confirmed that it anticipates its financial performance to meet market expectations, reflecting strong year-on-year growth for the year ending 31 December 2024, driven by organic expansion and strategic acquisitions.

However, technical factors contributed to Gamma’s share price weakness. Gamma is set to complete a move from the AIM market to the London Stock Exchange Main Market in Q2 of this year, a move befitting its size (current market cap over £1 billion)..  In the short term, an overhang from inheritance tax (IHT) investors may weigh on the shares due to the fact that tax relief status is lost when the shares move to the main market. However, following the move, greater liquidity and investor interest is likely to catalyse a reversal of this dynamic, particularly as the company’s size is likely to earn it a place in the FTSE250 index at the next rebalance. 

British American Tobacco exited the portfolio in March. The managers believe that over time, the company’s competitive advantage is likely to be eroded as it executes a business shift from legacy combustible products towards smokeless products such as vapes, where competition from areas such as China is fierce. The position has been actively sold down in recent months as the stock’s extreme undervaluation versus peers reduced over 2024.

Positive contributors included:

BAE Systems (+36%), Shall (+15%), Smiths Group (+12%), GSK (+9.8%) and AstraZeneca (+9.1%).

Negative contributors included:

RWS Holdings (-31%), Indivior (-29%), Next 15 Group (-27%), Renishaw (-24%) and Gamma Communications (-21%).

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