Liontrust UK Smaller Companies Fund research update

In many industries a single company, or group of companies, possess significant advantages over their competitors. For example, with thousands of recovery vehicles, the AA can provide breakdown services across the entirety of the UK. Any company trying to challenge the AA must build a similar network; not an easy feat. For other companies advantages may be intangible, such as patents to new drugs, innovative technologies, or a world-famous brand.

Many investors see these types of advantages as the golden ticket to success. But Anthony Cross and Julian Fosh, managers of the Liontrust UK Smaller Companies Fund, realise this is only half the story. They believe a strong advantage is worthless unless it is used to deliver consistent financial benefit to the company and shareholders.

For this fund the managers will only buy companies with valuable intellectual property, strong distribution networks or consistent recurring income. At least one of these is needed but more than one is preferred. The next stage is to determine whether these advantages are creating value for the company. The managers compare the cash flow generated by the company, with the cost of capital, ensuring the company is making more money than it costs to sustain the business.

Craneware is one of the fund’s largest holdings. Representing over 3% of the fund, it exemplifies these qualities. Craneware is the largest provider of pricing and billing systems to American hospitals. It generates over 70% of its revenue from recurring income and, with a 25% market share of US hospitals, its distribution network is extensive. Crucially, these advantages have been used to add value to the business since the managers invested in 2007.

Smaller companies struggled in 2014, but the fund was supported by a number of strongly performing holdings, particularly in the technology sector. Redcentric provides ICT solutions including network security and software maintenance. The share price increased 40% over the year as the company continued to display strong growth potential. The share price of Advanced Computer Software, another holding, increased 34% as a takeover bid was entered by private equity firm Vista Partners. Advanced Computer Software delivers IT systems to healthcare businesses and NHS centres.

Our view on this fund

This fund has performed strongly over the past 10 years, growing by 181.4%* compared with 131.7% for the average fund in the IA UK Smaller Companies sector and 82% for the FTSE Small Cap (excluding Investment Trusts) Index. As always, please remember past performance is not necessarily a guide to future returns.

Past performance is not a guide to future returns. Source: Lipper IM. *Figures to 02/03/2015.

Anthony Cross and Julian Fosh are two of our favourite UK managers. We are confident in their ability to perform well over the long term. However, the fund is not currently on the Wealth 150 list of our favourite funds across the major sectors – we currently prefer to access the managers’ stock picking talents through the Liontrust Special Situations Fund, which has greater flexibility to invest in UK companies of all sizes.

Find out more about this fund including how to invest

Please read the key features/key investor information document in addition to the information above.