Investors who want exposure to all levels of the UK market could do a lot worse than the Liontrust Special Situations fund, which has been one of the top picks among UK investors for several years – and for good reason.
The £6.4bn fund has been a top-quartile performer in the IA UK All Companies sector over the past three, five and 10 years, making investors 240.5% over the past decade. It has never slipped into the bottom quartile of its sector in any calendar year since 2011.
FE fundinfo Alpha Manager Anthony Cross has managed the strategy since 2005, with fellow Alpha Manager Julian Fosh joining in 2008.
Below, the pair tell Trustnet how their process has influenced the performance of the fund, why they were disappointed in their best stock of 2021 and why investors will rarely see a large bank or mining firm in their portfolio.
Total return of fund vs sector and benchmark over 10yrs
Source: FE Analytics
What is your process for picking stocks?
Cross: The first part of the process is the hunt for intangible assets, which we believe provide companies with barriers to competition, and hopefully pricing power and the ability to compound growth over a long period of time.
The second bit is to prove that these barriers to entry are working. We look at companies’ cashflow returns on invested capital, compared with the cost of capital.
The third part is, when we are buying a brand new holding in the FTSE 350, can we buy it at a valuation that is cheaper than the market? This gives us a margin of safety.
Why should investors pick your fund?
Fosh: We are the only people that are systematically looking at exploiting intangible assets and intellectual property, distribution, or high levels of recurring revenue in this way, and clearly it works.
All four of the funds we run have good long-term track records. It suggests we are either extremely lucky or we are on to a good thing.
How risky is your fund?
Fosh: It is a lower-risk strategy and that comes from the process itself. We don’t invest in loss-making businesses, no matter how exciting they are, we wait for them to become profitable. A lot of very exciting businesses never deliver on their potential, which is particularly relevant now.
Some people may see our use of small caps as a risk, but we can never have more than 30% in them and generally the types of companies we buy are not risky at all. They are long-term compounders and strong financially.
What has been your best call over the past year?
Cross: The one that has contributed the most is temporary-power firm Aggreko. It was a stock market darling a few years back, but it got hit by the general cyclicality of the market during Covid and the end of some very juicy contracts that were being renegotiated at lower levels. There were also environmental, social and governance concerns.
The shares were hit pretty hard and did not enjoy a strong Covid bounce. We topped up a bit and then bang, private equity came knocking on the day.
We were disappointed with the price paid. We felt on a long-term view it was not particularly generous and was opportunistic, so voted against the deal, but it was squeezed through.
The shares left the portfolio 40% higher than when we bought them. It added about 1.3% of performance to the fund in 2021.
And what has been the worst?
Fosh: We have TP Icap, which is the world’s biggest intermediary broker. The firm thought that the market would operate 10% by voice trading, 10% electronically and the rest would be hybrid – a mix of both.
It positioned itself as the largest player to cover all of these bases but there was quite a big profit warning two years ago and it became clear to us that electronic trading was going to be more than it thought.
What we got wrong was the complexity of the market. Over one year, the shares are down from £2.60 to £1.60.
What is the most exciting stock in the portfolio?
Fosh: We don’t tend to get too excited about individual stocks, but we do like to find out where the market has a strong view and question it.
For example, we own the big oil companies BP and Shell and lots of people are anti those companies for environmental reasons and are also concerned about whether they are relevant as businesses in the new world of low carbon renewables.
Our argument is that not only do they have strength of intellectual property and distribution, which fits our style, but those assets will play an important part in energy transition to zero carbon over time, enabling governments and businesses to use a blend of energy.
Do you use ESG in the portfolio?
Fosh: We absolutely do use ESG in the process but only at what we call ‘stage two’. If we found a business that we liked and it fit our criteria, we would then look at a number of risk categories such as financial risk and ESG.
If a stock has a poor ethical rating, it will result in a lower weighting in our fund. We will still hold it, we will just own less.
Are there any sectors you won’t invest in?
Cross: There are lots of sectors that you are unlikely to find us invested in. We don’t say never because things can change, but we struggle to find intellectual property and high returns on capital in areas such as mining; large retail banks; housebuilding, construction or property businesses; and consumer companies such as retail and leisure.
We also don’t own insurance businesses, partly because we find them complicated to understand or they are too cyclical and too many things are outside of their control.
What do you do outside of fund management?
Fosh: My passion is music. I play bass guitar in a jazz band on a Sunday and in a community band as well. I am not sure I am good enough for it to be a career, but it is my hobby.
Cross: I have always been quite a skier and fisherman. I am also keen on the countryside. Where we live, we have some land around us, so I like to plant trees and dig ponds.