Liontrust Special Situations: A year of resilience

In reviewing 2020 for our investors, we are pleased with the way the majority of companies in the Liontrust Special Situations Fund performed given the pandemic and the fact that all our lives were transformed. Our Economic Advantage investment process was tested and has again proved resilient.

In this article, we take you through the different phases of last year’s market and how the Fund performed during each of them. We will also review the best-performing stocks and those that were the source of greatest weakness for the portfolio in 2020.

The Liontrust Special Situations Fund had a resilient year during an extremely volatile 2020. The Fund returned -1.2%*, which was ahead of the FTSE All-Share comparator benchmark’s return of -9.8% while the average return in the IA UK All Companies sector, also a comparator benchmark, was -6.0%.

In understanding Fund and market performance in 2020, we think it is helpful to break down the year into three distinct periods: the Q1 market fall (31.12.19 – 23.03.20); the subsequent rebound (23.03.20 – 06.11.20) and the year-end vaccine rally (06.11.20 – 31.12.20).

Global stockmarkets began selling off heavily in February as cases of Covid-19 outside China accelerated. The FTSE All-Share fell very sharply before troughing in late March at almost 35% below the level it started the year.

During this sell-off, the Fund accrued good relative performance against the index, partly due to its insulation from some of the areas worst affected by the pandemic. For example, despite holding BP, Royal Dutch Shell and Wood Group, the Fund was actually underweight in the oil & gas sector itself, which at the start of the year accounted for 12% of the FTSE All-Share Index, and this restricted losses from the sector’s 49% tumble. The Fund also had low exposure to the financials sector, which fell by 35%; the portfolio has no holdings in banks or insurers, where losses were the worst.

After bottoming at the end of March, the market partially recovered, supported by huge government and central bank stimulus packages from around the world and lockdown measures being eased in many countries during the Northern Hemisphere’s summer months.

The Fund maintained pace with its peer group and outperformed the FTSE All-Share Index during the ‘market rebound’ phase between the market bottom and the 6^th of November. The industrials sector, to which the Fund is overweight, provided the biggest lift. The Fund’s small cap companies – particularly in the technology segment, where some of them benefited from the shift to remote working – were also prominent among the gainers.

With the release in November of positive trial results for Covid-19 vaccines under development by Pfizer/BioNTech, AstraZeneca/University of Oxford and Moderna, the stockmarket recovery suddenly saw a step-change in momentum, allowing it to shrug off the second wave of the pandemic. The upward adjustment in share prices was sharp; in November, the FTSE 100 recorded its largest monthly gain since 1989. All major market capitalisation segments of the UK market registered double-digit percentage gains. The breakdown of the market’s gains suggests a reversal of some of the trends witnessed during Q1: in many cases, stocks and sectors that were hardest hit by pandemic lockdown measures saw the greatest relief rally on vaccine hopes.

While the Fund rose 8.2%, the profile of the stocks that benefited the most during the vaccine rally meant the Fund lagged the returns of its peer group and the FTSE All-Share. For example, travel and leisure (a sub-sector of consumer services) is an area which tends to lack the Economic Advantage characteristics we look for but performed particularly well during this rally, rising by 23%. Similarly, the Fund has no exposure to basic materials (+20%) or banks (+21%) – a sub-sector of financials – which were among the biggest risers.

This return profile during 2020 is consistent with the manner in which the Fund is managed. Funds run under the Economic Advantage process have a tendency to generate good relative performance during market sell-offs or steady market conditions, which can be partially offset during short, sharp, sentiment-driven rallies.

This reflects the focus of the investment process on dependable businesses with high barriers to competition and strong cash flow returns on capital, which we think can prove to be more defensive in times of market stress and reliably deliver on expectations in more normalised market conditions. We believe that – on average – the degree of downside protection afforded by the Fund’s portfolio of companies exceeds the lag during rallies, enabling us to target outperformance over the long term.

Full-year stock analysis

Last year created significant disruption to the way companies operate. As explained above, the Economic Advantage investment process focuses on companies with strong cash flow and healthy balance sheets, and these tend to be better placed to survive during periods of turbulence.

We were pleased with the way the majority of our holdings traded in 2020. The biggest contributions to return can be broadly be placed into categories of companies which beat market expectations (both cyclical industrials and stable consumer goods), and those that have seen an uplift from behavioural changes during lockdown. The biggest detractors were the Fund’s oil & gas holdings and special situations such as Compass Group (a relatively rare ‘person-to-person’ contact holding for the Fund) and TP ICAP.

Perhaps surprisingly given the economic conditions throughout the year, the Fund’s holdings in the industrials sector were, on aggregate, a large source of positive performance. Prominent among this group was high-precision metrology and healthcare technology group Renishaw. A July trading update indicated revenue for its financial year to 30 June 2020 of around £510 million, down from £574 million the previous year, but ahead of analysts’ forecasts of £497 million.

Spirax-Sarco Engineering, the designer of products regulating steam and electrical thermal energy, also enjoyed resilience in trading, with organic sales falling only 5% in the first half of the year. This owes partly to some defensive characteristics of its sales: more than 50% are to less cyclical sectors such as healthcare, food & beverage and power generation & water treatment, and 85% of demand comes from clients’ operating rather than capital budgets. Engineering company Weir Group also caught the market’s attention with the sale of its Oil & Gas unit to Caterpillar for US$405 million.

Staying within the industrials sector, logistics, e-fulfilment and returns management specialist Clipper Logistics leads a group of stocks that experienced minimal Covid-19 disruption and – in some cases – enjoyed a trading uplift. Although many of its retail clients have been heavily affected by restrictions imposed during lockdown, Clipper Logistics is exposed primarily to online consumption and has therefore benefited from the shift in spending from the high street to online. In the year to 30 April 2020, revenues rose by 8.8% to over £500 million while operating profit increased 19% to £24 million. In a bullish outlook statement, management predicted that this year’s results would “comfortably” exceed market forecasts after the first few months saw exceptionally high demand for e-fulfilment and returns management services.

Both Domino’s Pizza Group and Keywords Studios were also among this group of stocks that experienced strong trading and share price appreciation during the pandemic. Domino’s Pizza Group has benefited from the boost to online sales as individuals spend more time at home. In the first nine months of the year, its sales rose 9% on a like-for-like basis as rising delivery orders more than made up for the drop off in collection orders, which were suspended during lockdown measures. Keywords Studios provides support services such as artwork and localisation services (e.g. translation) to video games publishers. It raised £100 million in new capital during the year to support acquisitions as it looked to accelerate consolidation of the market.

Research and analytics group YouGov was another prominent portfolio gainer; it stated that it has not seen a material impact from Covid-19 on its financial performance. While some of its retail clients have delayed projects or renewal decisions, there has been an increase in work from technology clients and the public sector, including on Covid-19 and health-related issues.

As an outsourced provider of IT design and support services primarily to the public sector and healthcare industry, Kainos Group also saw robust demand during the pandemic. The company has commented that the structural shift towards digital adoption has driven very high customer demand for its services. As a result, it stated that results for the year to 31 March 2021 are on course to materially exceed consensus estimates.

The biggest source of portfolio weakness emanated from the oil & gas holdings. A combination of reduced global demand during lockdowns and limited oil storage space amid a supply glut led oil prices to tumble, with the US West Texas Intermediate (WTI) oil future briefly trading at a negative price in April for the first time in history. Although it participated strongly in the late-year market rally, the oil & gas sector still finished 2020 as the FTSE All-Share’s weakest, down 41%. The Fund has sector exposure through BP, Shell and John Wood Group, all of which suffered heavy falls.

Some of the Fund’s companies with high exposure to person-to-person business also fared poorly given the significant level of business disruption from the pandemic. Compass Group is a notable example. In April, about half of the catering group’s business was closed due to various country lockdowns, which fed directly through to a 46% drop in organic revenue.

Fund Outlook

The pandemic over the past year, as with other crises, has shown the importance of focusing on a company’s ability to trade through a downturn and its potential to emerge on the other side in a healthy position to take advantage of any subsequent upturn.

In our view, the portfolio of companies held by the Special Situations Fund has strong barriers to competition, attractive market positions and a history of high returns, which should stand them in good stead. Once we get past the Covid-19 crisis, these companies could be able to take share from weaker competitors who have suffered more or ceased trading altogether.

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

*Source: Financial Express, as at 31.01.21, total return (net of fees and income reinvested), bid-to-bid, institutional class. Non fund-related return data sourced from Bloomberg.

**Source: Financial Express, as at 31.12.20, total return (net of fees and income reinvested), bid-to-bid, primary class. The FTSE All-Share and IA UK All Companies sector are both comparator benchmarks.

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