The fund’s 127.51 per cent gains put it third in the sector over that time, while it is second over three years, having made 82.71 per cent.
Performance of fund vs sector and index over 5yrs
Source: FE Analytics
Data from FE Analytics shows that FE Alpha Managers Anthony Cross (pictured) and Julian Fosh have achieved these returns with an efficient use of risk, and have the highest Sharpe ratio over the past five years in the IMA UK All Companies sector.
The Sharpe ratio measures returns relative to risk taken on, with a higher score meaning the manager has achieved better results per notional unit of risk.
Unusually, the fund has managed to outperform in both rising and falling markets, producing top-quartile returns in every single calendar year since launch with the exception of 2007.
In 2008 when the market lost 29.93 per cent, the fund lost 25.9 per cent, while in 2009 when the FTSE All Share rebounded 30.12 per cent, it made 41.2 per cent.
Performance of fund vs sector and benchmark since launch
| Name | 2012 returns (%) |
2011 returns (%) | 2010 returns (%) | 2009 returns (%) | 2008 returns (%) | 2007 returns (%) | 2006 returns (%) |
|---|---|---|---|---|---|---|---|
| Liontrust - Special Situations | 22.36 | 7.54 | 36.14 | 41.2 | -25.9 | 0.17 | 22.07 |
| IMA UK All Companies | 15.05 | -7.04 | 17.53 | 30.4 | -31.96 | 1.85 | 17.38 |
| FTSE All Share | 12.3 | -3.46 | 14.51 | 30.12 | -29.93 | 5.32 | 16.75 |
Source: FE Analytics
Unsurprisingly, the fund has become very popular, attracting more than £300m over the past 12 months, according to data from FE Analytics.
The managers are clearly extremely good at what they do, but it would be dangerous to assume their outperformance will continue for ever.
History is littered with funds that seemed to have cracked it for a few years – or many years – only to later go through a much tougher period. This makes it wise to dig a little deeper and ask why it has been so successful.
Liontrust Special Situations is managed according to a philosophy developed by Cross, which seeks to find companies with a defendable competitive advantage, usually based around intellectual property but also around distribution channels and strong customer loyalty.
The idea is to find companies with a business that is very hard for others to duplicate or muscle in on.
It is the same philosophy that Cross has used on the Liontrust UK Smaller Companies fund since 1998, which is another to have achieved impressive success over the past five years.
It has made 113.04 per cent over that time, the third-best returns in the IMA UK Smaller Companies sector. However, it was not always so successful.
Performance of fund vs sector and benchmark since 1995
Source: FE Analytics
Until late 2007, when it suffered less in the market crash that was beginning and rebounded faster, it was only marginally ahead of the IMA UK Smaller Companies sector.
From August 1995 to August 2007, the average fund made 306.4 per cent and the Liontrust fund 333.98 per cent. That put it 13th out of 25 funds in the sector.
The fund’s real outperformance has come since then, in which time it has made 64.23 per cent while the sector has gained just 27.71 per cent.
This is a similar pattern to that seen with Liontrust Special Situations, which performed well between launch in 2005 and late 2007 before taking off in a similar fashion during the rebound from the crash and producing exceptional returns.
It seems that Cross and Fosh’s strategy is particularly well suited to the current economic climate. One possibility is that it is easier for companies to build or defend a competitive advantage in a time of banking crisis.
With banks reluctant to lend to new businesses and companies building up cash on their balance sheets instead of investing in new projects, it is possible there are fewer challenges emerging to niche businesses than there might be in a more expansive economy.
Rob Gleeson (pictured), head of research at FE, says that although this is possible, he thinks the key is that the process is drawing the managers into sectors that have been particularly successful.
"It may be at the start of the recovery there will be an explosion of competitors, we don’t know this. On the other hand the managers may say they have seen plenty of competitors come and go," he said. "However, they have a particular process that leads them to certain sectors such as biotech that have done extremely well in recent years."
Liontrust Special Situations has 17.2 per cent in technology and 7.4 per cent in healthcare, both of which are sectors in which the intellectual property that the managers search for is key.
Furthermore, a number of the companies that fall under the industrials category are also essentially technology companies.
Domino Printing Sciences uses lasers to print identifying marks on eggs, while Smart Metering Systems makes meters that the Government is making mandatory over the coming years.
Data from FE Analytics shows that both sectors have outperformed over the past five years, with the FTSE All Share Technology index up 236.32 per cent and the FTSE All Share Pharmaceuticals & Biotechnology index up 94.87 per cent.
Performance of sectors over 5yrs
Source: FE Analytics
One of the fund’s largest underweight sectors is financials, which makes up only 6.2 per cent of AUM.
The financial sector has been among the best-performers during the rally of the last six months, and Liontrust Special Situations sits in the bottom quartile of IMA UK Smaller Companies over this time.
It is harder to see how a company could develop the sort of competitive edge the managers are looking for in financial services, as is the case with mining companies, another large part of the UK market that the fund avoids.
This would seem to suggest that the fund would do less well when those sectors lead the market, as they may do in a cyclical upswing.
Gleeson says that while he rates the fund very highly, it is currently benefiting from a market that suits it, and its outperformance cannot continue for ever.
"We like this fund very much, we like this strategy. The strategy is well defined and we can rely on it to keep on doing that; however, we cannot forecast how it will do in the future," Gleeson explained.
"It’s currently performing above expectations and logic would suggest it will underperform in certain markets."
"However, we do not expect the managers to have a bad period and then to change their strategy, which is why we are happy to hold it."
Gleeson says that if investors only hold Liontrust Special Situations, they are exposing their portfolio to a potential reversal when the economy shifts and the sectors favoured by the fund no longer outperform.
He thinks that Rathbone Global Opportunities and JM Finn Global Opportunities are suitable diversifiers.
"In a similar way, these funds are both looking for the companies that are benefiting from global economic changes."
"However, whereas the Liontrust fund is looking at companies with a defendable market position, JM Finn is looking for companies which have an up-and-coming market position."
"For example it holds a Malaysian oil storage company which is 95 per cent full. They think that over the next 10 years it will do very well."
"This is a similar approach in that they are looking for companies with a competitive advantage and it’s a strategy they have bought into, and they are not fickle but are just looking at a different market."
"It’s emerging market-driven, focused more on infrastructure and basic materials in emerging markets rather than new technologies."
"It’s a proven strategy and at times it will do well and sometimes it will do badly."
"Rathbone Global Opps is similar but looking for companies that have made incremental improvements to existing products."
"For example, it holds Rightmove. They have understood the world has changed and they are in a good place."
Gleeson explains that FE Alpha Manager James Thomson has been more cautious in recent years than may have been expected, given his stated aims.
Having lost considerably more than the sector in 2008, the manager has consistently held a high cash weighting.
Earlier this week he told FE Trustnet that he was finally reducing that position, moving from 20 per cent to 12 per cent in cash.
Gleeson says it remains more defensive than the other two portfolios, however, which could prove to be a "masterstroke" or misguided investment, depending on what the markets do this year.
Diversifying between these funds should reduce the risk of being exposed to any one strategy, Gleeson explains, all of which will have periods of outperformance and underperformance.
The first article in this series highlighted the reasons for Neptune UK Mid Cap’s outperformance.