- Short-term performance impacted by three key headwinds: Size, Style and Sector
- But the high-quality footprint of our portfolios is as pronounced as ever, while valuations have compressed to generational lows
- This presents a compelling total return outlook, with high forecast earnings growth and healthy dividend yield levels supplemented by substantial scope for valuation re-rating.
The quality of businesses in portfolios remains exceptional
Despite the extreme valuation multiple compression experienced by our funds’ companies in recent years, analysis of fundamentals gives us the comfort that the calibre of those companies has not, at a portfolio level, deteriorated. The quality of the businesses in the portfolios remains exceptional. For illustrative purposes, we include below data from the Special Situations Fund, but you could replicate a very similar picture for any of our UK-focused funds.
Source: Canaccord Genuity, 04.06.25. Liontrust Special Situations Fund statistics are a weighted average of holdings in the portfolio. 1. Equilibrium Growth is the real rate of capital growth which a company can generate from internally generated free cash flow, calculated after paying out interest, tax, dividends, buybacks and maintenance capex, data as at 20.05.25
CFROC and CFROA are cash flow return on capital measures sourced from Canaccord Genuity Quest that we use explicitly within the process; clearly the Fund's weighted average is substantially ahead of the wider market.
Gross and operating margin are also both comfortably ahead of market, as you would expect for a quality style.
Leverage is low – aided by the owner-manager culture within our small caps conferring a conservative attitude to debt onto the managers of our smaller businesses.
Lastly, equilibrium growth rate. This is a measure of the real rate of capital growth that can be sustained by a company from its own internally generated free cash flow after deducting shareholder distributions. Effectively, it represents the sustainable free cash flow that can be actively reinvested by a company back into growth. Here, the Special Situations Fund scores between three to four times more highly than the wider UK market.
Valuation at generational lows
For that level of quality, we would usually expect to be paying a reasonably full price. But we currently sit at a juncture which represents an extraordinary opportunity.
Valuation is not the primary driver of long-term equity returns for a style like ours, but it can be a very significant factor in the short term – and that short term opportunity for a pronounced re-rating boost has not looked this attractive since the global financial crisis.
Free cash flow yield
Source: Style Analytics, 30.04.25, Liontrust Special Situations Fund
Earnings yield
Source: Style Analytics, 30.04.25, Liontrust Special Situations Fund
Again looking at the Special Situations Fund as an example, we can trace weighted average free cash flow yield and earnings yield back to the Fund’s inception. Excitingly, this shows that we have not been able to buy high-quality businesses at such attractive prices since the economic tumult of 2008/9. For those with long-term time horizons, it is hard not to see this as a compelling opportunity.
Inbound takeover activity remains elevated across the fund range
The valuation opportunity has not been missed by corporate acquirers. The investment process has always experienced a lot if inbound M&A interest, but since 2022 the Funds have had 18 takeovers of companies at an average premium of 44% - clearly illustrating the level of value acquirers are seeing.
Source: Liontrust, June 2025. Average premium shows average bid premium to last closing price for completed takeovers since 01.01.22. *Completed includes companies the funds have fully exited its position ahead of formal takeover completion. All use of company logos, images or trademarks in this presentation are for reference purposes only
Compelling total return outlook
Ultimately, the long-term driver of portfolio returns will be companies’ ability to sustain high returns on invested capital and growth rates, and compound these for longer than the market expects, fuelled by their powerful barriers to competition.
Combining the 12-month earnings growth forecast and expected dividend yield from companies gives us a baseline target portfolio return outside of any potential boost from revaluation.
Source: Style Analytics to 30.04.25. Liontrust Special Situations Fund, earnings growth and dividend yield figures based on 12m forecast consensus.
The earnings growth forecast for the next 12 months is around 8% (Special Situations Fund). In the context of significant macroeconomic and geopolitical uncertainty buffeting companies at the moment, that is a very robust number. It is only a couple of percentage points lower than the long-term average of 10%.
If we layer on the 3% expected dividend yield from the portfolio, we get an expected baseline return of 11%. Compounding at 11% for a number of years would clearly generate an excellent investment return. If there is any additional boost from a valuation re-rating or a cyclical earnings growth recovery to long-term average (i.e. from 8% currently to 10%), then that would further enhance returns.
Three years of size, style and sector headwinds
We retain every ounce of our conviction in the investment process, the companies it leads us into, and their ability to deliver really strong returns over the long run.
But in the short term, of course, market forces are changeable and we would characterise the last three-and-a-half years – a period of predominantly rising interest rates – as having three significant headwinds to our approach.
Size: for a stockpicking process like ours, which frequently seeks out long-term alpha in companies further down the market cap scale with a longer runway of growth ahead of them, the outperformance of large caps has been difficult.
Source: FE Analytics, 31.12.21 to 31.05.25.
Looking at the stark underperformance of AIM over this period, it has obviously been a market that has suffered from its growth bias and tilt towards the smallest companies, but also has experienced unhelpful speculation over the future of its tax-advantaged status.
AIM has played a really important historical role as a growth market in incubating some of the best long-term small cap investment ideas that have delivered so much alpha for the process over decades. As such, we are encouraged by ongoing efforts to reinvigorate the market, from moves to improve its branding and its regulatory regime (ensuring it is fit for purpose for smaller issuers), to its potentially significant role in helping pension funds deliver their commitments to ‘unlisted’ domestic equity allocation in line with the updated Mansion House Accord.
However, it is crucial to understand that we are agnostic about our companies’ listing venue. A number of our holdings have already left or have indicated an intention to leave AIM for the Main Market – and we remain supportive of them no matter where they are listed; we are only concerned with the calibre of the businesses in which we invest, rather than their listing venue.
Style: The Bloomberg Factor-to-Watch indices show the value factor has been the dominant driver of UK equity returns as interest rate have risen, substantially outperforming quality and growth. Our investment process is explicitly designed to target the quality factor, targeting companies with high returns on invested capital.
Source: FE Analytics, 31.12.21 to 31.05.25; Bloomberg FTW (Factor To Watch) index returns are derived from the FTSE 350 based upon Bloomberg’s proprietary equity factor models for Value, Quality and Growth
This has also been a strong headwind for our funds, given that across the board they identify most strongly with the quality factor, which is explicitly targeted via the second stage of the investment process, focusing on selecting companies with high returns on invested capital. Most of the funds also exhibit a strong tilt towards growth.
Sector: This factor is obviously linked to style, with banks forming part of the value baskets. The 135% return for the FTSE All-Share Banks sector has – due to the sector’s weight in the index – amounted to a 10% headwind to relative returns over the period given that we’ve made a long-term, high-conviction decision not to invest that sector. We believe that banks historically have proved themselves to be very poor compounders of capital, with low earnings quality given their elevated risk profile and inescapable dependence on interest rate movements which are outside of their control.
Source: FE Analytics, 31.12.21 to 31.05.25.
Retaining our high conviction approach and avoiding style drift
Even when presented with these short-term headwinds, we remain fully committed to the style exposures which result from the consistent application of the investment process.
Morningstar style analysis shows the Special Situation Fund’s high conviction, long-term overweight to small and mid caps has been stable amid a volatile environment, while the index and IA sector average have both shown capital shifting into large caps – and mainly into value, which is not where we are positioned.
The large-cap value trade has been a painful process to observe, but even though the trend has been clear for all to see, we need to avoid style drift and stick to the high-conviction approach investors in our fund expect.
Fully committed to our investment process and its style profile
The Special Situations Fund style tilt since inception – almost 20 years of data – further illustrates this consistency of stylistic positioning:
Source: Style Analytics, 30.04.25, and 31.12.24. Liontrust Special Situations Fund. Data is available for 202 peers within the IA UK All Companies sector peer group
Since the early years of the Fund’s life, the pro-quality tilt has been really consistent, with no deterioration in recent years. Similarly, the Fund has exhibited a strongly consistent, positive tilt to growth and away from value, albeit that has narrowed a little in recent years due to the rating compression of its companies.
Within the IA All Companies peer group, this style factor tilt places the Fund in the 8th decile for value, but within the 3rd decile for growth and in the top decile of peers for quality.
Looking to the future with excitement
We know that it has been a challenging couple of years, but from here that challenge represents opportunity.
We feel that our investment process, and the high-quality businesses it leads us into, is a clear differentiator. It has worked across the market cap scale for many years, and we are confident that the calibre of our businesses will again translate into strong alpha generation as the cycle turns again in favour of small and mic cap and quality growth businesses.
At this point in time, there is a clear opportunity, both in the short and long term - in being able to buy great businesses at valuations not seen in over 15 years and holding them to benefit from their strong compounding potential over many years. We look to the future with excitement
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 Funds managed by the Economic Advantage Team:
- May have a concentrated portfolio, i.e. hold a limited number of investments. If one of these investments falls in value this can have a greater impact on a Fund's value than if it held a larger number of investments.
- May encounter liquidity constraints from time to time. The spread between the price you buy and sell shares will reflect the less liquid nature of the underlying holdings.
- 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.
- May invest in smaller companies and may invest a small proportion (less than 10%) in unlisted securities. There may be liquidity constraints in these securities from time to time, i.e. in certain circumstances, a 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 a fund to defer or suspend redemptions of its shares.
- Outside of normal conditions, 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.
- May be exposed to Counterparty Risk: any derivative contract, including FX hedging, may be at risk if the counterparty fails.
The risks detailed above are reflective of the full range of Funds managed by the Economic Advantage Team and not all of the risks listed are applicable to each individual Fund. For the risks associated with an individual Fund, please refer to its Key Investor Information Document (KIID)/PRIIP KID.
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.
