Liontrust SF European Growth Fund

The Fund returned 1.6% over the quarter, underperforming 5.2% from the MSCI Europe ex-UK Index and the 3.8% IA Europe ex-UK sector average (both of which are comparator benchmarks)*.

Volatility remains rife in markets, with violent moves between sectors and factors and uncertainty surrounding new strains of the pandemic. Macroeconomic debate continues to centre on long-term versus transitory inflation and the ability of central banks to control prices without disrupting recovery and we saw a first rate rise in the UK over December and the US Federal Reserve outline eight potential hikes over the next three years. For now, the European Central Bank remains one of the more dovish and maintains its patient approach, with concerns about a significant slowdown in the eurozone. The Bank voted to leave interest rates unchanged while its pandemic emergency purchase programme (PEPP) will end in March. As we said last quarter, increasingly hawkish policymakers have caused a rotation back into the ‘value‘ part of the market and many of our favoured quality growth companies have lagged.

Global supply chain issues are exacerbating inflationary forces as aggregate demand recovers from the depths of the pandemic and pricing power remains critically important for businesses to protect margins as costs rise. Our process looks beyond these shorter-term issues, however, and focuses on the themes that are driving our economy in the next decade and beyond as it becomes cleaner, healthier and safer.

Over the quarter, top performers included Nagarro, with this IT engineering business building software solutions for blue-chip clients such as BMW, Roche and McKinsey and held under our Increasing the resource efficiency of industry and agricultural processes theme. Back in October, the company announced the acquisition of New Jersey-based Advanced Technology Consulting Service; the company has a strategic focus on areas including digital, data, and analytics and the tie-up gives Nagarro access to the US and German markets, as well as a deeper presence across Asia-Pacific. Following the deal, Nagarro has subsequently been able to revise its 2021 revenue guidance upwards twice, rising from €515 million to €525 million in November and then to €535 million the following month. Estimates for gross margin and adjusted EBITDA margin remain at 28% and 14% respectively.

Q3 addition Alcon has made a strong start in the portfolio, with this Swiss-American medical device company specialising in design and manufacture of interocular lenses, consumables used in ophthalmic surgery and consumer contact lenses. The company has recently spun out of Novartis and is going through a period of reinvestment and renewed innovation, resulting in market share gains over the last 18 months and evidence of a strong, long-term orientated management team. Alcon is another business exposed to our Enabling innovation in healthcare theme, tackling the growing issue of vision impairment. Nearly a billion people have a preventable impairment and the company tackles this with both its products and foundation, which spends roughly 1% of sales on treating this affliction in developing economies. For the third quarter of 2021, Alcon’s worldwide sales were $2.1 billion, an increase of 15% on a reported basis compared to the same period the previous year.

Two other 2021 purchases are also among top contributors, with Cancom sitting in our Enhancing digital security theme; formally, around a third of the business is related to security but the reality is that all its services enable security and efficiency for clients. The company is growing organically at around 10% a year and we believe the valuation is in line with long-term UK holding Softcat in this space. Over the first nine months of the year, Cancom generated revenue of €947.9 million, a 12.9% rise on the same period last year.

Lifco, meanwhile, held under our Providing affordable healthcare theme, acquires small and medium-sized business in areas including dental materials and equipment. The company reported a 24.9% rise in net sales over the first nine months of 2021, driven by a combination of organic growth and acquisitions. During this period, Lifco consolidated 14 acquisitions, with four in the dental area, and many of these are market leaders in their respective niches.

Puma is another holding benefitting from strong numbers, posting a 20% Q3 increase in currency adjusted sales and revising its financial year 2021 outlook upwards to sales growth of at least 25% (up from 20%). CEO Bjorn Gulden said this is despite various operational challenges, with a Covid-related lockdown of production in South Vietnam, an overheated global freight market, port congestion and a difficult situation in China. We see the business as a strong fit for our Enabling healthier lifestyles theme, with around 33% of its sales derived from sportswear, which enable people to take part in sports, increase activity and tackle obesity.

Elsewhere, several of our long-term semiconductor, healthcare and financial holdings also featured among top contributors, including Infineon and ASML in the former, Roche and Lonza in the middle category, and Rilba (Ringkjøbing Landbobank) in the latter.

Weaker names over the period included Zur Rose Group, with its shares falling as the German health minister announced the expected mandatory introduction of e-prescriptions in medical practices, pharmacies and clinics in January will be postponed as ‘necessary technical systems are not yet widely available’. While we anticipated digitalisation would be bumpy – innovative change is never easy – such an indefinite delay was unforeseen.

Zur Rose has reaffirmed its medium-term guidance, believing that, five years from now, 10% of prescriptions will be digital. Equally, reimbursement of telemedicine appointment to patients starts in January and the company has the biggest platform for this. Having seen the trajectory in countries like Sweden, we continue to believe in our thesis and expect prescriptions and GP appointments will increasingly move to a digital basis across Europe. Zur Rose is in prime position with brand and technology but when you have something requiring buy-in from intransigent groups, you have to prepare for slow, volatile B roads before you hit the motorway of fast adoption.

Another detractor in Q4 was TeamViewer, held under our Connecting people theme, and again, we exited this business over the period. This is a global platform that enables corporates to connect to computers and mobiles safely and securely and we feel the company has failed to execute on the growth opportunity, with a recent profit warning to a market expecting significantly higher growth rates. Management also demonstrated a lack of understanding of effective asset allocation, spending shareholder capital on advertising vanity projects unlikely to drive growth. We therefore sold the position as it failed our fundamental quality assessment.

After a long process of engagement and analysis, we also decided to sell our remaining position in Kingspan Group towards the end of the year. We have invested in Kingspan for more than 15 years and have held the company in high regard for the benefits its products bring, playing a key role in energy efficiency in buildings and therefore carbon dioxide emission reduction. Revelations from the Grenfell Tower Inquiry, however, have raised concerns about the culture and controls within the insulation business.

We initially decided to downgrade Kingspan’s sustainability rating (in our proprietary matrix) from A1 to A4 in December 2020, a significant reduction in terms of management quality. This means we view a company as higher risk and its weighting in the portfolio fell substantially as a result. Our view at that stage was to reserve final judgement until after the Inquiry concludes and we could discuss the findings and recommendations with the company’s management and other parties. As part of continuing engagement, we requested a meeting with the new Chairman to understand his view of how the culture has changed, and needs to change further, towards safety. This has not been forthcoming, however, which is disappointing given our large holding and long-term support of the business. This lack of engagement has prevented us from improving our rating from A4.

There are also more fundamental issues to consider. With the share price currently around 105 euros, on our modelling, the company has to deliver faultlessly over the coming years for there to be upside. On balance, factoring in concerns on valuation, culture and management rating, we feel now is the right time to exit.

Additions over Q4, meanwhile, included Evotec, an outsourcing company employing around 3500 scientists used by biotech and pharmaceutical businesses to increase efficiency and speed to market, while reducing R&D costs. The company is paid by charging for its scientists’ time, in a consultancy model, and also participates in any upside from treatments developed through equity or royalties. We believe the outsourcing theme is an important growth trend driving healthcare cost efficiency and the company sits in our Enabling innovation in healthcare theme.

Another new purchase under this theme is GN Store Nord, a global leader in the design of hearing aids and ‘unified communication’ devices. With an ageing population, and growing middle-class, the hearing aid addressable market continues to grow steadily. GN has consistently outgrown the market with innovative new features, such as mobile connectivity, and is also developing lower-cost devices for people with mild hearing loss. Unified communication devices include professional headsets and video cameras used by companies in video conferences – which is important in the new remote and hybrid working environment.

Finally, we introduced Swedish private equity company Kinnevik, which strongly integrates sustainability into the selection and management of investee companies. It provides capital and support to companies in healthcare, e-commerce and food, and financial services that are challenging incumbent models.

Discrete years' performance*, to previous quarter-end:

* Source: Financial Express, as at 31.12.21, primary share class, total return, net of fees and income reinvested

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