There is little doubt that Liontrust Special Situations, which recently celebrated its 10th year, has been one of the best and most consistent funds in the highly competitive IA UK All Companies sector.
Using FE Alpha Managers Anthony Cross and Julian Fosh’s ‘economic advantage model’ – which centres on finding companies with intangible strengths such as intellectual property, distribution channels and repeat business as well as strong barriers to entry – the fund has managed to outperform in most of the last decade’s varying market conditions.
FE data shows, for example, it has been sector’s fifth best performing portfolio (out of a possible 190 funds) over 10 years having beaten the FTSE All Share’s returns by close to three times.
Performance of fund versus sector and index over 10yrs
Source: FE Analytics
It is also outperforming over one, three and five years having beaten the index in six out of the last nine calendar years and looks set to do so again in 2015 with its top quartile returns of 10.36 per cent.
Given the fact that Cross and Fosh’s approach leads them to hold high quality, cash-generative companies with reliable earnings, Liontrust Special Situations has also been one of the sector’s best from a downside protection view as well.
According to FE Analytics, it sits in the sector’s top decile for its annualised volatility, maximum drawdown and risk-adjusted returns (as measured by the Sharpe ratio) over 10 years. 
That performance profile has, unsurprisingly, led to increased flows into Liontrust Special Situations. The fund was £612m three years ago but now stands at £1.6bn.
This begs the question, given the fund has been renowned for being a multi-cap product for most of its life, are the managers facing capacity constraints?
Cross, who originally launched the fund and honed his trade on the Liontrust UK Smaller Companies fund, says the strategy is genuinely scalable and says if flows continue at a relatively slow rate, he and Fosh could run the fund at more than double the size.
“I think we can grow the fund, with low-turnover and steady inflows, to be quite a bit bigger. I look at a fund like Nigel Thomas’ AXA Framlington UK Select Opportunities fund, which is around £4bn and has quite a lot of small-cap in it, and I can easily see Special Sits at £3bn or £4bn – but not overnight,” Cross (pictured) said.
This may well calm investors but the manager adds that the growing AUM has affected the way in which he can manage the portfolio.
“There is absolutely no doubt that there are certain smaller companies that we can no longer do, size wise,” he added.
“To get a unit position in Special Situations you need to spend about £15m to get even a 1 per cent position within the fund. You have to really be an £150m market-cap or more business before we could buy you now.”
“That doesn’t mean we can’t buy fantastic small companies but we don’t get as much of that micro-cap juice or power.”
While this may not seem like a huge problem in itself, Cross says that over the fund’s life some of its best success stories and main drivers of outperformance have been stocks within that sub-£150m bracket.
For example, the managers highlight Brooks Macdonald – the AIM-listed wealth manager – as one of their best investments. FE data shows that it has returned a hefty 1,340 per cent over 10 years, for example.
Performance of stock versus index over 10yrs
Source: FE Analytics
The point is, though, the company had a market-cap of £17m when it was brought into Liontrust Special Situations.
Many industry commentators warn about the impact size can have on performance as managers who see their AUMs increase may either have to hold more of a company’s total shares or increase the number of stocks in the portfolio – either way, their fund is no longer the same entity which outperformed in the first place.
The growing size of the fund caused IBOSS’s Chris Metcalfe to sell it earlier this year and replace it with CF Miton UK Value Opportunities.
“We were looking at the fund flows of the Liontrust fund and £80m went into it last month and it is now £1.4bn. As far as we are concerned, although there is no real science to it, we don’t see any benefits to a fund getting bigger; it only reduces the manager’s investment universe – especially if the managers will buy smaller companies, like they do in Liontrust Special Situations,” Metcalfe told FE Trustnet in January.
He added: “I don’t see any advantages of the fund getting bigger, only potential disadvantages.”
It must be pointed out, of course, that it is only the 23rd largest fund in the sector, has outperformed this year despite its growing AUM and the managers have a very low-turnover approach to the market.
But given the fund is no longer the same offering it was a few years ago, what should investors in the fund do?
“I don't think investors should be concerned,” Jason Hollands, managing director of business development and communications at Tilney Bestinvest, said.
“While the Special Situations fund can no longer invest in very, very small companies, at its current size I don't think this should hinder its ability to continue delivering very strong returns from investors but clearly any strategy that has a meaningful small cap component will eventually reach capacity.”
He added: “I can't help feeling this has been a factor compounding the performance issues on M&G Recovery, for example.”
M&G has stressed on a number of occasions that Tom Dobell has not faced any capacity issues in his now £3.9bn Recovery fund (which was more than £8bn in 2011) and that its recent performance has been driven by style-related and stock-specific issues.
However, following 10 consecutive years of outperformance relative to the FTSE All Share and sector average, it has underperformed in each of the last four calendar years (and is bottom decile with losses of 4.64 per cent in 2015).
This means it is now bottom decile over five years and underperforming over 10 years, which has led many to question how much of an impact size has had on performance.
Performance of fund versus sector and index over 5yrs
Source: FE Analytics
Hollands added: “The Liontrust model gives me comfort this won't happen there. The business is a multi-boutique which is very much a federation of autonomous investment teams, each of which has strong ownership of their processes.”
“The business provides infrastructure and distribution support to these teams, but doesn't not drive them. Given the Liontrust model, I am very confident that if and when the Special Situations fund approaches a size where Anthony and Julian feel the process might start to come under pressure, the fund will be soft closed.”
Hollands says that is still some way off, but given the group is set to launch a micro-cap fund using the same process next year, investors may want to dovetail the two portfolios to “capture the full lifecycle” of businesses that meet their criteria
Gavin Haynes, managing director at Whitechurch, is also relatively relaxed about the size of the fund.
“You just have to accept it. When a fund gets bigger, like we have seen with Nigel Thomas’ fund, the manager has to adapt their style,” Haynes said.
“However, if you look over the past 10 years, some of their best success stories it has been the small-caps that they have bought. Their approach now has to be different, as they will struggle to spot those very small companies or take meaningful positions in them.”
He believes, though, the fund should be viewed differently by investors than in the past as it is no longer the peripheral holding it might have once been.
“It has changed its spots as it is now more of a large-cap focused fund rather than its small-cap bias it had a long time ago. However, if you want a core stock-picking UK fund, I would say it is a very good option.”
Liontrust Special Situations has an ongoing charges figure of 0.87 per cent.
