Fund research company Morningstar has downgraded Nick Train’s two largest UK equity funds, citing concerns that their sheer size could create capacity problems in the future.
Morningstar, which rates funds based on expectations of future performance, has downgraded £6.7bn LF Lindsell Train UK Equity Fund (GB00B18B9X76) accumulation share class from gold to bronze and £1.8bn Finsbury Growth & Income Trust (FGT) from gold to silver. Morningstar said that, following hefty inflows in recent years, the concentrated funds had built up “significant ownership stakes” in their holdings that could expose them to liquidity or other problems. LF Lindsell Train UK Equity took in £1bn on a net basis in 2017 alone, according to separate Morningstar data.
“While such large ownership levels do not conflict with the long-term investment approach, they could make [LF Lindsell Train UK Equity] far less nimble to respond to adverse circumstances, including a significant liquidity event,” said Peter Brunt, associate director at Morningstar. He added that Finsbury Growth & Income Trust was less vulnerable to liquidity problems because of its closed-ended structure but that the volume of assets controlled by Mr Train’s UK equity funds could hinder the future performance of them.
“The large asset base precludes Mr Train from building sizeable positions in opportunities further down the market-cap scale,” he explained. “While this has not had a large impact on performance so far, allowing assets to continue to grow will only further restrict his potential investment opportunities. In light of this, we are concerned that [Lindsell Train] has not taken action to manage capacity.”
Morningstar added that both funds still benefited from "a highly experienced and longstanding manager and a unique, well-structured investment approach”, meaning that both still have a positive rating. Lindsell Train said that estimates of capacity across its UK equity funds suggested there was “more headroom” for further growth. “Broadly, today we think our capacity is in the region of £12.5bn compared with the current assets in Lindsell Train’s UK strategy of around £9.5bn,” said the firm. Lindsell Train also acknowledged the investment risks of running a concentrated portfolio,7 but added that this had been a key contributor to returns.
Investment specialists are paying greater attention to fund capacity in the wake of last year's Woodford controversy, and in November fund ratings provider Square Mile also downgraded LF Lindsell Train UK Equity from AAA to A for similar reasons.
The company praised the fund’s performance, but said: “Given the current liquidity levels within the underlying stocks held there could be significant issues should the fund experience a prolonged period of and/or a sizeable level of redemptions.”
Broker Hargreaves Lansdown, meanwhile, removed LF Lindsell Train UK Equity and Lindsell Train Global Equity (IE00BJSPMJ28) from its Wealth 50 list of suggested funds last year, citing the fact that the funds had significant amounts of money invested in the platform itself.
“Given the continued popularity of the funds we anticipate the investment in Hargreaves Lansdown shares could grow further and so we are removing them from our favourite funds list in line with our procedures,” said Lee Gardhouse, chief investment officer of Hargreaves Lansdown.
LF Lindsell Train UK Equity and Finsbury Growth & Income, which had the same top 10 holdings as each other at the end of November and have a similar composition, have delivered handsome returns over the past decade, resulting in strong inflows to the former. LF Lindsell Train UK Equity returned 321.3 per cent over 10 years to the end of 2019 and Finsbury Growth & Income Trust made a share price total return of 366.4 per cent. By contrast, the FTSE All-Share is up 118.3 per cent over the same period and the Investment Association UK All Companies fund sector average is up 129.7 per cent.
