Liontrust UK Micro Cap Fund

March 2020 review

The Liontrust UK Micro Cap Fund returned -21.2%* in March. For comparison, the FTSE Small Cap (excluding investment trusts) Index returned -25.8%, the FTSE AIM All-Share Index returned -20.3% and the average return of funds in the IA UK Smaller Companies sector was -22.5%.

 

The current economic and social situation is without precedent. The stockmarket reaction has been sharp and pronounced, but in this respect the Economic Advantage team does have a certain amount of knowledge to draw upon; investing through periods of volatility and uncertainty is not new to them. The team has been applying the Economic Advantage investment process for over 20 years, a period which includes previous sharp sell-offs such as the technology correction at the turn of the century and the financial crash of 2008.

 

During these previous bouts of stock market turbulence, the strict adherence to investment process has served the Economic Advantage funds well. Its strengths should again prove important during the coronavirus crisis. In times like these, having a clear investment process is invaluable as its decision-making framework ensures the team continues to take a rational approach to managing the portfolios.

 

About 70% of the Fund is in three areas: industrials, technology (mainly software) and financials. The Fund has low exposure to classic UK consumer cyclicality and ‘person-to-person’ contact such as travel, transport, pubs/restaurants, retailing, leisure and aviation.

 

The fund managers are, however, well aware that this crisis will negatively affect nearly all businesses. The process of individual companies updating investors on the specifics of the coronavirus disruption is still in the early stages. The overall impression is that it is very difficult for most companies to make any meaningful forecast of the likely impact, which makes the FCA’s decision to allow an extra two months to prepare annual financial statements look like a sensible step.

 

The Fund’s heaviest fallers in March includes a few examples of companies heavily exposed to the coronavirus fallout who, understandably, have struggled to project the likely impact. Brick and tiles distributor Brickability Group (-45.3%) stated that earnings for the year to 31 March will be in line with forecasts following strong trading over the last six months, but that it cannot issue any financial guidance for next year due to the current restrictions on businesses and individuals. The company has closed all sites and ceased all discretionary spend.

 

Vianet Group (-45.1%) delivered a very similar message, confirming trading for the year to 31 March was in line with expectations but warning of the impact of mandatory closures of pubs, bars and restaurants. The company provides data and analysis to pubs and vending machine operators via its connected ‘internet-of-things’ (IoT) platform. Vianet has offered reduced rates to help support its client base and is taking advantage of government schemes to fund its cost base – by furloughing employees – and liquidity, via guaranteed loans. The company states that prudent modelling suggests these measures will leave it sufficient cash to survive the likely duration of this crisis, as forecast by the government.

 

Training provider Mind Gym (-38.5%) issued an update which warned of a deterioration in conditions since the end of January. It noted an increased rate of cancellations and material reduction in new bookings. This trend restricted revenue growth in the year to 31 March to 10% - 15%, below Mind Gym’s previous expectations, and the company has not provided any guidance for the new year.

 

In the current environment, investors are focusing as much on companies’ balance sheets and funding positions as on the immediate hit to business levels.

 

The Economic Advantage investment process determines portfolio holding sizes based on a risk assessment that includes a number of measures, including financial risk. This checklist approach to determining the holding sizes of investments may seem rather pedestrian during a bull market, but it really comes into its own during setbacks. We have reviewed the balance sheet strength of our companies and are comfortable with the portfolios, but these are extraordinary times and working capital shortfalls can occur quickly.

                                                                                                                                      

This is particularly true at the lower end of the market cap range where fixed costs could swiftly eat up cash resources if sales or production are halted. Working capital shortfalls are obviously a key short-term concern for many investors but we have been encouraged by the government’s action in promising loans. The terms of these loans remain to be seen, so we could well see a second round of re-financing needed for companies further down the line. 

 

We entered this crisis owning a portfolio of companies that generate profits and have solid balance sheets: over two-thirds of them had net cash and a similar proportion paid a consistent dividend. This reflects the cash generative, low capital intensity nature of these stocks. Even those that do have debt on the balance sheet have only very conservative levels.

 

Given the circumstances, we have written to the brokers of all our companies – regardless of how well-funded they appear – and impressed upon them the importance of acting quickly if equity funding is needed. By acting early, they will put themselves in a better position to secure funding; this was one of our takeaways from the experience of the 2008 credit crunch.

 

Another feature of the small and micro caps stocks we own is that they all have a strong owner-manager culture. We have a minimum threshold of 3% management equity ownership on these stocks, but the average is closer to 20%. These teams have lots of ‘skin in the game’ and at times such as these, the practice of investing alongside management takes on a lot more significance.

 

The Fund retains high cash levels, giving the opportunity to support companies if an equity raise is required.

 

One silver lining to the market rout is that the managers have been able to initiate a few new positions in the Micro Cap Fund where companies’ market capitalisation has fallen into the Fund’s buying territory (below £175m). Last month the Fund initiated Churchill China after it temporarily dipped into buying range and this month it built a position in Accesso, an existing holding in the Special Situations and UK Smaller Companies Fund.

 

The Fund also took part in the early-March IPO of FRP Advisory Group, one of the large insolvency practitioners in the UK, which the fund managers believe has both intellectual property and distribution strengths.

 

Harwood Wealth Management exited the portfolio following completion of its acquisition by Carlyle.

 

While near-term returns for the Fund’s holdings will obviously be heavily challenged by the current environment, the managers have high conviction in these companies. The market will regain its poise and one should be mindful of how sharp the upturn could be when this happens. If valuations remain depressed for an extended period of time, mergers and acquisitions should be expected to play a role in unlocking value. The intangible assets the Economic Advantage process targets in its investments have historically proven appealing to corporate acquirers and we would expect this to remain true were corporate activity to pick up again.

 

Positive contributors included:

Accesso Technology (+12.1%), Dotdigital (+2.3%) and Concurrent Technologies (+1.6%).

 

Negative contributors included:

Brickability Group (-45.3%), Vianet Group (-45.1%) Adept Technology (-40.8%), Mind Gym (-38.5%) and Quartix (-38.1%).

 

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

 

Mar-20

Mar-19

Mar-18

Mar-17

Liontrust UK Micro Cap I Acc

-8.2

5.7

18.4

22.1

FTSE Small Cap ex ITs

-24.4

-3.1

2.2

19.7

FTSE AIM All Share

-24.5

-8.5

10.5

32.9

IA UK Smaller Companies

-17.9

-2.6

14.9

18.7

Quartile

1

1

2

2

 

*Source: Financial Express, as at 31.03.20, 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 31.03.19, total return (net of fees and income reinvested), bid-to-bid, institutional class. Discrete data is not available for five full 12 month periods due to the launch date of the portfolio. Investment decisions should not be based on short-term performance.


For a comprehensive list of common financial words and terms, see our glossary here.

 

Key Risks 

Past performance is not a guide to future performance. Do remember that the value of an investment and the income generated from them can fall as well as rise and is not guaranteed, therefore, you may not get back the amount originally invested and potentially risk total loss of capital. 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. The performance of the GF UK Growth Fund may differ from the performance of the UK Growth Fund and will be lower than its corresponding Master Fund due to additional fees and expenses.

Disclaimer

The information and opinions provided 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.  Always research your own investments and (if you are not a professional or a financial adviser) consult suitability with a regulated financial adviser before investing.

Thursday, April 9, 2020, 3:42 PM