Liontrust Special Situations fuelled by stocks with pricing power

One factor that has contributed to recent performance is the fund's holdings in global businesses. The weaker pound has meant that companies with high overseas earnings have seen these increase when translated back into sterling. But manager Anthony Cross says the fund's 'economic advantage' investment approach means its stocks tend to be more resilient.

Mr Cross developed this stockpicking approach in 1997 and has used it across all the funds he manages ever since. The key element of the economic advantage approach is buying businesses that have at least one of three attributes: intellectual property, such as patents and trade secrets; strong distribution channels; and significant recurring business.

"These give a company strength in pricing power and if they've got that it means they're difficult to copy," Mr Cross explains. "If a company has got some structural growth behind it - gentle or fast as we're not fixated on fast growth - then it allows it to compound out earnings over a long time. And it's that quiet compounding effect that is so powerful."

He and co-manager Julian Fosh aim to buy and hold stocks that can achieve this compounding of their share price. The low turnover approach means eight out of the fund's 51 holdings have been held since launch in 2005. These are Concurrent Technologies (CNC), Fidessa (FDSA), GlaxoSmithKline (GSK), Next Fifteen (NFC), Renishaw (RSW), RWS (RWS), Spirax Sarco (SPX) and Wilmington (WIL).

Following this investment style means the fund tends to avoid certain areas and this has helped performance this year.

"We don't find intellectual capital in housebuilders, leisure, retail or construction, and have never owned a big bank," says Mr Cross. "We also don't own mining shares. After the Brexit vote those areas, particularly the consumer cyclical ones, had a tough time, although they've rebounded a bit."

Companies with pricing power are also better placed to cope with the increased inflation the UK has seen since the Brexit vote, he adds. This is because they often have strong brands and can pass on some or all the cost of inflation rather than taking a hit to profit margins.

The high-profile spat between Unilever (ULVR), one of the fund's top 10 holdings, and Tesco (TSCO) last year was an example of the tensions between companies over increased costs. Although Tesco was able to refuse Unilever's demand to raise prices on products such as Marmite, supermarket Morrisons (MRW) did give in and hiked prices on more than 90 Unilever products. As well as Marmite, Unilever has a number of other strong brands, including Dove, Lynx and Ben & Jerry's.

Another of Liontrust Special Situations' top 10 holdings that has strong brands is drinks giant Diageo (DGE), which owns Smirnoff, Guinness and Johnnie Walker. The fund also holds consumer goods company Reckitt Benckiser (RB.), owner of Nurofen, Strepsils and Dettol.

Mr Cross and Mr Fosh recently bought Dotdigital (DOTD), a fast-growing software business with a product called Dotmailer that enables interaction between marketing professionals and their customers. This business ticks all three economic advantage boxes, with intellectual property in its software, a strong embedded distribution network and recurring revenues of more than 75 per cent as its software is based on monthly rental. It has also benefited from a partnership with Magento, a global e-commerce software vendor.

Mr Cross and Mr Fosh have also recently bought market research business YouGov (YOU). They believe the company has economic advantage through a data-driven distribution network and intellectual property via a vast bank of proprietary data collected from its research over time.

Although Liontrust Special Situations is able to invest across the market capitalisation spectrum it has a smaller companies bias. Around 39 per cent of its assets are listed on the FTSE 100, with 31 per cent on the FTSE 250 and 15 per cent on the FTSE alternative investment market (Aim).

Mr Cross says: "There are some great ideas in that space. We could invest more than 20 per cent of the portfolio in that area, but we're holding off a bit because the market as a whole and a lot of the larger small-caps are quite punchily valued."

But as the fund has grown in size to £2.55bn, the size of the smaller companies it buys tends to be at the larger end of the scale - £150m and above.

As of the end of February, the fund had a relatively high proportion of its assets in cash, at 9.5 per cent. But the managers say this does not reflect directional market views or an attempt to provide downside protection.

"Current cash levels are above average, reflecting the effect of fund inflows and investment decisions to reduce certain individual holdings," they say. "The nature of stock sales is that cash receipts are realised fairly rapidly - especially, for example, in the case of a takeover - whereas with new holdings we tend to build up our positions slowly to be mindful of the market impact of our investment. We would expect the fund's cash weighting to now trend lower."

Examples of recent sales include the disposal of cyber security specialist NCC Group (NCC) in December. This was because the company had grown rapidly over the past few years, but more recently hit some difficulties in the form of a tough integration process for the Fox-IT business and the loss of some large contracts.

Source: Morningstar as at 16/03/17,*Liontrust Fund Partners as at 31/01/17

Performance

Source: Morningstar as at 15/03/17

Top 10 holdings as at 28/02/17 (%)

Source: Liontrust

Sector breakdown as at 28/02/17 (%)

Source: Liontrust