Having managed money for more than 20 years, Liontrust Asset Management’s Anthony Cross has developed a number of investment rules and beliefs that have helped deliver strong returns on highly rated strategies such as Liontrust Special Situations and Liontrust UK Smaller Companies.
Since 2000, Cross has made a total return of 446.64 per cent compared with a gain of 195.20 per cent for the peer group average.
Performance of manager vs peer group since 2000
Source: FE Analytics
Below, FE fundinfo Alpha Manager Cross (pictured) details his “straight-forward rules and beliefs of investing” in greater detail.
Make clinical not emotional investment decisions
The first rule is ‘make clinical not emotional investment decisions’, with Cross describing equity investing as an “intellectual battle against the market’s perceived mispricing”.
He said investors are often impatient when it comes to buying but when selling “the emotion is frequently reversed, particularly if the investment has gone sour.
“No one likes to crystallise a loss and selling will underline that an intellectual mistake has been made,” he explained. “Denial is frequently the default response leading many investors to continue holding the stock.”
Having a clear set of investment rules means that emotional investment decisions can be avoided Cross said, which applies to his selling discipline as much as his investment thesis. 
And this relates to Liontrust’s proprietary ‘Economic Advantage’ process, which seeks out companies with one of three intangible assets: intellectual property, strong distribution or recurring business (at least 70 per cent of annual turnover). These intangible assets provide barriers to competition, protect margins, and are capable of reaping cash flow returns in excess of the cost of capital.
“So, when a company we are invested in encounters difficulties, we need to judge whether it is suffering from a general industry downturn or whether we should be questioning its long-term possession of competitive advantage,” he said. “If there is evidence that its competitive advantage is undermined, we will sell.”
Successfully predicting macroeconomic events is exceptionally difficult
With the worst global pandemic in a century triggering one of the worst recessions on record along with several geopolitical challenges, this year has been full of ‘Black Swan’ events.
And these types of “exogenous economic shocks” are unavoidable and unpredictable, according to Cross.
“We believe it is better to concentrate on the selection of companies capable of outperforming over the cycle,” he said. “We adhere to an investment process that does not involve the prediction of political outcomes.”
He added: “We believe that our businesses, with their strong barriers to competition, attractive market positions and history of high returns, are in a good position to navigate this difficult time.”
Pricing power helps insulate against such exogenous shocks
The Alpha Manager said another way to think about the barriers to competition which can make a business successful is pricing power, “the ability to maintain prices and profit margins in a crowded and competitive marketplace”.
“This is an attribute that should be particularly highly valued by investors during periods of economic uncertainty, when consumer confidence and spending may suffer,” Cross said.
One of the clearest and simplest ways that a company can possess substantial pricing power is through a brand, added the Liontrust manager, explaining the presence of several well-known consumer discretionary brands among the top holdings of Liontrust Special Situations.
Don’t rely too much on one-dimensional valuation metrics
For his fourth rule Cross said that when it comes to popular valuation metrics their simplicity “is the reason behind both their power and their limitations”. For example, price-to-earnings (P/E) ratio is easy to calculate but earnings are hard to forecast.
“Because we look for companies whose barriers to competition can allow strong earnings to be sustained for longer than is expected, actual earnings often transpire to be higher than the forecasts used in P/E ratios,” he explained “This means that a company’s share may actually be cheaper than the P/E ratio suggests.”
He added: “Instead, make full use of your valuation toolkit, exploiting the strengths and recognising the weaknesses.”
Heed Warren Buffet’s advice
“It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price.” So said veteran investor Warren Buffet and something which Cross believes carries a lot of weight.
He said: “In other words, it is better to buy a company with characteristics of high quality – such as good cash flow returns on capital invested – than one that looks attractive on a simple valuation metric.”
In-depth examination of valuation metrics is at the back end of the Economic Advantage team’s investment process and is subordinate to the key business characteristics that it looks for.
Don’t set share price targets
Cross said the stock market is full of examples of companies that look expensive and have gone on to deliver even more share price gains but aren’t the types of companies he looks for.
“Our aim is to buy high-quality companies with defendable barriers to competition,” he said. “We then watch them very carefully to make sure the barriers remain intact and the financial performance is as expected.”
Don’t worry too much about benchmark constitution
The type of investment opportunities identified by the ‘Economic Advantage’ are more commonly found in certain sectors of the stock market than others, according to Cross.
“If a company or whole sector fails to have the intangible assets we look for, we are happy not to own it,” he said, nevermind what the benchmark looks like.
Look for company managers who have ‘skin in the game’
When investing in companies Cross said he looks for businesses where the management is one of the largest shareholders.
“Shareholders want management to make decisions that are in the best interests of the business and owners, but face the risk that managers will instead be guided by self-interest,” he said.
“One of the best ways of reducing this problem is to look for incentive alignment through managers who are also large shareholders.”
This is harder for larger companies, said Cross, but with smaller companies the team look for managers who own at least 3 per cent of the company’s shares – “giving them a significant economic interest in the business”.
Follow Dr Ramo’s approach to ‘Winning by not losing’
US physicist and engineer Dr Simon Ramo suggested the idea that in amateur tennis the match’s outcome was determined by the player who made the most mistakes.
Summing up Ramo’s idea, Cross said that by keeping the ball in play for as long as possible, your opponent will at some point will probably make a mistake.
In investment terms, Cross said both professional and amateur investors will struggle to consistently pick the stock market “winners” in the short term, which he likened to “trying to play a winner on every point”.
“One might pick a few stocks that shoot the lights out, but it is likely to come at the cost of a number of failures,” he explained.
“The best approach is to keep things simple, play your own game, concentrate on your defences and avoid the costly losing shots. Or, in more conventional investment terminology, pick stocks that you believe will outperform in the long term.”