Liontrust Special Situations Fund January 2022 review | Insights

Past performance does not predict future returns. You may get back less than you originally invested. Reference to specific securities is not intended as a recommendation to purchase or sell any investment.

The Liontrust Special Situations Fund returned -6.4%* in January. The FTSE All-Share Index comparator benchmark returned -0.3% and the average return in the IA UK All Companies sector, also a comparator benchmark, was -3.7%.

The -0.3% index return looks fairly innocuous, but beneath this headline number lay a number of influential trends which help explain the Fund and IA sector’s underperformance.

Chief among these influences was a sharp rise in interest rate expectations. Concerns over inflationary pressures and the monetary policy response were a feature of 2021, but central banks were largely happy to take a wait-and-see approach. In January, statements from the US Federal Reserve delivered a strong message that quantitative easing would finish in March, with US interest rates also likely to be raised in the same month and continue to be hiked through 2022 at a faster rate than had been anticipated.

As well as driving up bond yields (US and UK two-year government bond yields both rose around 30bps to 1.1% and 1.0% respectively), the prospect of higher interest rates prompted a sharp equity market rotation away from ‘growth’ stocks – which suffer from higher discount rates applied to their future forecast earnings – and towards ‘value’ stocks, which, by contrast, are viewed as short-duration assets less affected by discount rates.

The rotation shows up dramatically in MSCI index data: the UK value series outperformed its growth equivalent by 12 percentage points in January alone.

The Economic Advantage investment process applied to this Fund is a bottom-up, stock-picking process. We do not set out to achieve any style bias outcomes within the Fund. But because the process seeks out dependable, consistent businesses with barriers to competition, high financial returns and strong balance sheets, there is an observable style footprint that emerges: a tilt towards ‘quality’ and away from value. The investment process doesn’t actively target companies with high forecast EPS (earnings per share) growth, but this often goes hand-in-hand with the characteristics it does seek, such as high cash flow return on capital; this is particularly true of the Fund’s smaller companies.

In a stark risk-off environment, there was also a size bias to equity market returns; while the FTSE 100 index made a positive 1.1% return, the mid-cap FTSE 250 lost 6.5% and the FTSE Small Cap returned -3.9%. The FTSE AIM All Share Index fared even worse, losing 10%.

As well as having a pro-quality and anti-value tilt, the Fund also has a bias away from the FTSE 100 and towards mid and small caps. The Fund has 39% exposure to the FTSE 100 – well below its 80% weight in the FTSE All-Share – with 29% in FTSE 250 stocks, 2% in FTSE Small Caps and 22% in AIM stocks.

Over the last few years, the Fund’s style and size profile has been a tailwind to performance, particularly during the recovery from the initial Covid-19 sell-off in early 2020. Not surprisingly, many of the stocks and funds – including Liontrust Special Situations – that were resilient and outperformed last year, suffered a reversal in January as tailwinds became headwinds.

While the Fund’s smaller companies allocation has been a significant source of alpha generation over the years, in January it detracted from performance. The shift in investor sentiment away from high forecast growth and small caps can be clearly seen through a quick appraisal of the Fund’s largest detractors in January.

AIM-listed YouGov (-26%) shares lost a quarter of their value despite issuing a trading update which upgraded full-year financial guidance. Impax Asset Management (-26%) suffered a similar fall despite only reporting another quarter of solid growth in assets under management. Craneware (-22%) tumbled as a half-year trading update maintained full-year guidance but it noted that one of its revenue lines has been temporary affected by an elongation of the sales cycle and staff shortages due to Omicron. RWS Holdings (-21%) and Kainos Group (-21%) didn’t issue any earnings updates.

Overlying all of this discussion of style factors is of course the fundamental truth that we are bottom-up stockpickers, and every stock is to some degree a mixture of many different style sub-factors- sometimes even 'value' and 'growth' and 'quality ' at the same time.

The Fund did have some exposure to companies with at least one foot in the ‘value’ camp, including GlaxoSmithKline (+2.3%) and the oil & gas sector stocks - Shell (+17%), BP (+16%) and John Wood Group (+16%) – which also benefitted from a 17% rally in the oil price (and a positive trading update in John Wood Group’s case). But these positive contributions were outweighed by weakness elsewhere in the portfolio.

In our experience, January often sees an automatic reversal of the trends that worked well the previous year. On this occasion, it’s very hard to predict whether these headwinds will persist or ease. Our investment process explicitly excludes any form of macroeconomic forecasting in favour of pursuing the bottom-up approach that has served us so well over the years.

While the equity market narrative around rising inflation and interest rates currently centres on the value versus growth debate, it may well develop to incorporate more nuanced factors, such as which companies possess the pricing power to maintain margins within an inflationary environment. One of the fundamental characteristics we look for in companies we invest in is a durable competitive advantage which confers a high degree of pricing power. A company with true pricing power can pass on some or all cost inflation rather than having to absorb it through a reduction in profit margins.

The evidence so far is that our companies are coping well in the current environment. Overall, we’ve found that trading updates across the portfolio continue to be positive, with expectations being met or exceeded. We have seen some caution in outlook statements, as companies continue to draw attention to global political and economic uncertainties which are out of their control, such as supply chain problems.

While the Fund’s style, size and sector footprint were all unhelpful in January, it performed exactly as we would expect it to given the prevailing conditions. Over the long term, the consistent application of our investment process has yielded very good returns. Even if the market correction has further to go, we have high conviction in our stocks and every reason to believe they will continue to add value over the long run.

Positive contributors included:

Shell (+17%), BP (+16%), John Wood Group (+16%), GlaxoSmithKline (+2.3%) and Compass Group (+1.9%)

Negative contributors included:

YouGov (-26%), Impax Asset Management (-26%), Craneware (-22%), RWS Holdings (-21%) and Kainos Group (-21%).

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

	Dec-21	Dec-20	Dec-19	Dec-18	Dec-17
Liontrust Special Situations I Inc	20.5%	-1.2%	21.6%	-2.1%	16.8%
FTSE All Share	18.3%	-9.8%	19.2%	-9.5%	13.1%
IA UK All Companies	17.2%	-6.0%	22.2%	-11.2%	14.0%
Quartile	1	1	3	1	2

*Source: Financial Express, as at 31.01.22, total return (net of fees and income reinvested), bid-to-bid, institutional class.

**Source: Financial Express, as at 31.12.21, total return (net of fees and income reinvested), bid-to-bid, primary class.

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Key Risks

Past performance is not a guide to future performance. The value of an investment and the income generated from it can fall as well as rise and is not guaranteed. You may get back less than you originally invested. 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.

Some of the Funds managed by the Economic Advantage team invest primarily in smaller companies and companies traded on the Alternative Investment Market. These stocks may be less liquid and the price swings greater than those in, for example, larger companies.

Disclaimer

This is a marketing communication. Before making an investment, you should read the relevant Prospectus and the Key Investor Information Document (KIID), 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. Always research your own investments. 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.

This 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. It contains information and analysis that 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 of this document, no representation or warranty, express or implied, is made by Liontrust as to its accuracy or completeness, including for external sources (which may have been used) which have not been verified. It should not be copied, forwarded, reproduced, divulged or otherwise distributed in any form whether by way of fax, email, oral or otherwise, in whole or in part without the express and prior written consent of Liontrust. Always research your own investments and 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.