In Episode #16 we spoke to Anthony Cross, head of Liontrust’s Economic Advantage team which is responsible for a franchise of UK equity focused investment strategies including the Liontrust Special Situations Fund.
In each episode of our Investor Insights Podcast we will be interviewing portfolio managers from across the investment industry to gain from the expertise in their specialist areas and to question them on the topical issues.
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This podcast is not personal advice. This material is intended for educational purposes only and is not investment research or a recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy. Some of the views expressed by our guest speakers may not be representative of our own views. The value of your investments can rise as well as fall and you could get back less than you invested. Past performance is not a guide to future performance. The investments referred to in this Podcast may not be suitable for all investors and you should seek advice from a qualified investment adviser. Killik & Co is authorised and regulated by the Financial Conduct Authority (FCA).
it is now difficult to argue against the fact that activity and interest in the UK markets is increasingly gaining traction the financial times last week highlighted data from deal Logic the financial analytics company evidencing that the total value of bidding activity for London listed companies has this year hit its highest level since 2018 with $78 billion worth of deal making being instigated the majority of which coming from overseas buyers seeing value in the UK assets forward UK Equity markets have caught up ground to match that of global Equity returns so far this year but the significant underperformance from prior years means the UK Market trades on a near 30% price to earnings ratio valuation discount to the global market a rating which represents a far far wider discount than the long-term historical average it is no coincidence that several of the early episodes in the investor Insight series have focused on the UK and today we explore the current opportunity further with one of the most experienced fund managers running UK Equity mandates on the market hello and welcome to the investor insights podcast hosted by kilick and Co my name is Gordon Smith and and in each episode I’ll be interviewing portfolio Managers from across the investment industry to gain from their expertise in the specialist areas in which they invest and to question them on topical issues you can access the full series of interviews via the playlist on the kilick and Co YouTube channel we hope you’re enjoying the discussion so far and you can get in contact with us about any of the topics discussed via our email address investor insights kick.com kilino is an independently owned wealth manager which opened its first office in 1989 and provides services to help families save plan and invest and you can find more details on the unique ways in which we do that at our website kick.com in today’s episode we speak to Anthony cross from Lion trust Asset Management Anthony is a hugely experienced UK fund manager having joined lion trust in 1997 and heads up the company’s economic Advantage team which is responsible for a franchise of UK Equity focused investment strategies the lion trust special situations fund which we referenced in our conversation is the broadest mandate run by the team as it is able to invest across a wide variety of different siiz businesses a strategy often termed a multicap approach the philosophy used by the team can be distilled into attempting to identify companies with a durable competitive advantage that allows them to defy industry competition and sustain a higher than average level of profitability or longer than expected this competitive Advantage can come in different forms and Anthony discusses some examples as we go through our conversation this was clearly an interesting time to speak to Anthony given the increasing corporate activity under way within UK markets at the present time and Anthony and his team have been highly active in recent years at campaigning for policy changes to help reinvigorate interest in the UK Market both domestically and on an international stage Anthony good good afternoon how how you doing today I’m good gold thanks very much and thank you for having me on your podcast no thank you for joining thank you for spelling the time um so our kind of first question um attempts to get a bit of a an insight into you really in your kind of typical working week or what you’ve been working on recently and so I wondered if there was kind of any any interesting articles or books you’ve be been reading or or just an anecdote from a recent company meeting or or trip you’ve done just any anything you can share share there yeah so lots going on I mean you know to be honest there’s no typical day and in many ways that’s fantastic so I really like the variety sure clearly the core of what we get up to is is stop picking researching reviewing stuff uh quite a lot of time will be spent also talking to clients marketing the funds um and then there’s also the unexpected you know there’s the kind of corporate activity there’s sometimes takeovers you know we have an approach for keyword systems today um and then sometimes sadly there’s the old profit warning that you’re dealing with so it’s always really really varied and a really nice example of a stop picking uh time we had quite recently was with shell and we saw the chat who’s a a Dutch guy so i i d try and pronounce his name but he’s been with shell for 28 years and runs the trading Supply and marketing businesses within shell he he WR about six divisions now if each division was its own separate PLC each of those divisions would sit within the footsie 100 so he he’s dealing with a lot of businesses and some of the things that we really got out of the meeting was just you know further emphasis on know the distribution power that’s C have been share now we know that there are you know very very big in in areas like liquid natural gas distribution uh they’re the third well one of the top three uh biggest energy trading businesses in the world and that energy trading is really really important to the energy transition um you know the ability to trade different types of energy for clients is is really really valuable they’re also the biggest retailer in the world they’re the biggest s s seller of Coke coca coma uh their Red Bull the biggest seller in the world um so there sort of 46,000 Fort science that they have you know is a very powerful distribution Network too uh and then finally we talk a lot about AI in the business it’s going to be really important to how they uh can can you know utilize the data that they have within their bu business you know areas like maintenance protic maintenance uh predictive safety things you can you can really speed the process of AI so that was an interesting discussion that we had with shell yeah I think if you were to have asked me to put together a list of those largest retailers I perhaps wouldn’t have put shell up there at the top of that list but there’s clearly a huge amount of traffic going through those those Four Courts every day a pretty a pretty powerful distribution Network for sure um so I mean as as we see it today doing doing the record with I mean UK large cap markets are are sitting near enough at kind of alltime high but that that kind of masks what’s being a pretty challenging period for for UK investors or UK markets and kind of dting valuations and and quite notable underperformance um relative to other other markets around the world for the for the last several years now I I know you you and the team have kind of done a lot of work campaigning for for policy changes to address kind of this this kind of weak investor flow which I guess is one of the the big fact factors here um I wondered if you could kind of run through some of the work you’ve done there and what you would consider the kind of primary reasons for that that kind of negative sentiment and what what perhaps could be done in your view to to re reinvigorate things in the UK yeah I mean I’ll come back to what we we’ve been actively doing on the lobing but you know it’s a story really like many problems around of a number of factors have just been eitting away at the UK Equity market for a number of years and I also think that a number of those factors are now going the other way since things are starting to improve but let’s you know let’s explore the the challenges firsts the negative factors as they were first you you know You’ have the long-term shift of the UK Pension funds moving from equities uh into other areas whether it be you know private Equity but also into other areas are likee other Global equities so moving away from New equities into other Investments um you’ve also had the wealth managers so know the private wealth managers the people who look after uh you know the the cash of of individuals that um have been moving much more towards Global indues and away from the UK Equity market and they’ve been shifting that way for a number of years now so again that’s been put putting pressure on UK Equity shares you’ve also out of the RS of passive investing now it’s not that necessarily a problem for large cap companies because passive funds will be by larger companies but it is a problem for smaller companies and some of the midcap companies because the passive funds don’t tend to buy them therefore the rise of passive funds has had a bit of a he for you know UK smaller companies and typically UK active managers like ourselves um the interest rate shift so higher interest rates were hard work for for UK equities for the first time lots of individuals you know who previously might have saved in shares suddenly thought themselves oh I can now own you know maybe bonds which are more attractive or I can just put my money into a Satan’s account so that shi and interest rates had a had a part to play too in people moving out of equities were not buying as much of them and then you had the whole problem of sort of Politics the volatility of changes of party leadership changes of of sort of you know of government um and then the the perception around brexit as well was probably a a bit of an issue for the UK Equity market so when you ended up with you know valuations getting very very cheap um and the sort of Doom Loop continued you know if the UK Market became cheap it becomes a smaller part of global indes um and you get that kind of what we call the Doom Loop occurring um now what can what can improve what what what’s got better why am I now much more optimistic well one thing is is and this is where we’ve tried to play our part is that government have finally got it and and also theed the opposition opposition the labor party in that you need to give much better support to the to the Mark um and you can achieve this through a number of ways one is try to improve the regulation of the market to make it a more attractive place for people to list their businesses um but importantly you can try and put more emphasis on UK Pension funds investing back into the UK market and there will be I think greater pressure on Pension funds to do that and the first start of that is to get them to display much more how much they actually have in the nucle equity Market that’s what they do in Australia and other markets um you can also try and encourage encourage the wealth managers back into the UK Market you know the retail investors to through things like the British Isa so that’s another way that you can try and get things going so we did lot of lobbying of both um you know the Civil Service side but also the treasury and richy’s advisors um to try and know really make the point greater support is needed for the UK Equity market so government’s woking up so that that’s good news there’s also I think a flavor that you know there was passive investing can be very powerful and the people who are pro it would say look it’s very self-cleansing it’s up good companies and companies that are underperforming become a smaller part of the passive indices but there is a danger that momentum after a while creates too much concentration and then price Discovery is not really happening at a at a good enough level so a bit like elastic bound you know passive investing create momentum it can create concentration but at some point that concentration can become the danger and like an elastic band it can start to ship the other way when it’s got too tight so you know that could be a way that in many ways active management starts to look relatively more attractive because if passive starts to have problems with that concentration uh active managers can can make money more easily by much more Diversified portfolio so yeah I think passive fund funds might might actually be a reason why active management starts to suddenly improve um then you’ve got interest rates that are starting to come down so that’s attractive and I think the UK has forecast to have some rate Cuts maybe June onwards so that would be good news so relatively shares or attractive and particularly smaller company shares and and midap company shares higher growth businesses tend to you know enjoy better performance with interest rates are lower and then there’s the old politics um you know one of the great things about the UK is the strength of the rule of law and yes we’ve been through you know some political challenges as in you know changes in leadership and and and bits of turmoil but you know democracy remains intact governments change leadership changes and things don’t fall AP so you know the UK REM remains a very attractive place to invest as I said there the rule of law strength of democracy strength of the legal system strengths of the financial markets and I know I think people are you know rewarming to the UK um as a as a place of of of strongman and and stable uh law and democracy uh you’re also seeing GDP starting to improve a bit so they’ve come out of a more difficult period so people are saying well the UK market in terms of the UK economy is looking more interesting and you’re also seeing m&a activity start so you know you’ve seen the Anglo American bid you know a big big business being bid for but also a number of smaller companies midcap companies are big bit for too so at long last there are a number of signs and a number of reasons why it’s actually quite easy to be much more supportive of the UK Market um and the UK Market has you know started to actually out for some of the other markets in the world and guess what Brokers are finally recommending that the UK Market needs quite attractive UBS are much more positive on the UK uh HSBC today said the time is now we up upgrade the UK to overweight so a long answer but there’s lots and lots of bits that caused the UK to have a tougher time and I’m quite optimistic that a lot of those negatives are now starting to become positives yeah no thank you for that there’s lot lots of important points in there we might come back to the uh the point of IM Anda um if there’s time in a later question um and it’s interesting when you talk about that kind of Doom loop on the way down in terms of sentiment you can see when factors start to change in the other direction it it occurs in the uh to the positive as well with kind of self-fulfilling uh optimism starting to creep in So yeah thank you for that and I mean hly you’ve you’ve um kind of very experienced been running kind of UK strategies through a number of Cycles I wondered if you were able to put kind of the current opportunity kind of where valuations are in the context of of History kind of Prior versus other other periods that you’ve been through how how uh how big is the opportunity at the moment would you say I think the opportunity is very big particularly in in small cat um and midcap know the period reminds me quite a lot of sort of 2008 2009 period now clearly we haven’t been through a sort of financial crisis but the crunch down in the value of small cap companies particularly in 2008 created substantial opportunities in terms of valuation um and then they bounced back very very strongly in 2009 so you know if you’re looking today at sort of small cap valuations and we use a a database um at a team Called Quest who were part of canical genuity and Quest have done a lot of work on the valuation of the UK Equity Market um and whilst large capap has you know started to perform quite strongly this year um and has moved from being where they see it is as having moved from being 34% cheap to now 14% cheap mid W cap is still very cheap and they’re at least 25% cheap and if you look at other conventional measures so that’s 25% of discounted cash flow if you look at other conventional measures so you might be taking a PES or or just simple yields they think small cap and midcap is about 30 to 40% cheap compared of its longer on average so you know that’s where the opportunity is and that as I say it reminds me of that area 2008 when everyone was very very bleepy and then you had that terrific bounce back in 2009 and I’m hoping that there’s going to be you know a strength of bounce back um this year um particularly in the small cap and midcap um after after what we’ve seen as a a kind of earlier bounce in in large cap I wonder if we maybe delve a bit deeper into the the portfolio itself and there’s a number of strategies that you run um with with the team but but the special situations fund has kind of the freedom to invest right across the UK market and and up and down the market cap scale the portfolio does look quite different to the the kind of broader index and mean investors just looking at the kind of top down at the the UK index we’ll see kind of that concentration towards things like the banks and the miners and but the strategy your strategy always kind of found a number of opportunities in in other areas and Industrials has been a kind of big sector for you I know could you maybe just give some examples it’s such a broad sector the industrial sector I wondered if you could give some examples of the types of businesses within those areas and some of the kind of common characteristics that you’re looking for yeah so it’s I mean I I I love the special it’s fun that it you know it’s it’s beautifully Broad in the sense that you have 20 to 30% in small cap over 40% in the putsy 100 and then typically around about 30 odd per in the footsy 250 so you know it really is genuine or uh product and enables us to go into areas under the process that are super attractive in terms of long-term compounding and it is and what we’re kind of looking for is tangible assets so things like intellectual property distribution power either big scale networks like un Le diio or much more modern datadriven networks there could be a company like right move or could be a a business which is involved with software or media where you’re you know creating data that’s distributed and embedded in your own customers we like companies of high contracted recuring income so sort of fee based subscription businesses and then under that we like companies of Brands and culture and customer relationships so the whole idea is intangible assets and the idea is that they create for our company a really strong barrier to competition the ability to retain pricing power and the ability hopefully to compound growth that were long time and Achieve High Returns on invested Capital so you get into that virtuous circle at producing strong returns that could be reinvested in your business to go on producing further strong returns and as you say you know we we areas your fing are not always uh uh like the rest of the market so we don’t own any banks we don’t own any bance but we have got as you say a lot of industrial businesses and the beauty of industrial businesses is that they are often quite different therefore in in a sense you know there could be a nice spread of they don’t have the same characteristics so ready Shore in Precision me measurement is very different to Road talk and actuat um or very different to a couple of sparo in in Ste so lots of different industrial businesses but they do share the intellectual property strength they do share the distribution strength they share the brand ownership they often share very deep customer relationships so you know that’s an area which is very attractive and they’re of very share of friendly businesses you know they they’re not businesses that are stared by proms or people who walk out and demand you know big pay and big status you know these are businesses that think longterm yes they invest in their people but they also invest in the longterm their distribution networks and intellectual property also the style will take us into areas like media certain data businesses data Rich companies like global data in market research uh quite a few software companies companies like cadware or digital or Sage group and also some financial service companies with recuring income so you know businesses in the platform space H’s landown Integra AJ Bell businesses that have had a tougher time of late because of some element of Fe feed pressure but also you know markets that have been more subdued but like the markets are picking up now they’re they’re seem they seem to be in in better better heart um so lots of different businesses big big businesses like Relic smaller businesses like gamma Communications but lots of really interesting companies with the ability to compound growth over a long time see you mentioned in a in a previous answer briefly about kind of m&a activity that we’re seeing and I guess these kind of types of periods in the cycle often do lead to kind of higher corporate activity or certainly kind of Greater focus on on kind of capital allocation decisions could you maybe just discuss just how significant recent kind of corporate activity has been and and i’ also be interesting has this been a period which has kind of led to higher engagement by you with with management teams with that with that regards kind of in terms of kind of capital allocation decisions yeah I mean it’s been it’s been active in i’ there’s been roughly one takeover a week so far this year so know that could end up being at this rate you know over 50 takeovers um if if that continues work again by Quest you know shows just how cheap lots of businesses are there’s they have 289 companies with leverage buyout free cash flow year old above 10% and it’s above 10% that typically sort of private Equity or buyers get quite interested in that free cash flow and 205 of those out of the 289 are under 1 billion in market cap term so they’re quite digestable by bigger businesses if they want to come and do m&a so it is significant and I expect a lot more of it as the year progresses particularly if you get you know particular the UK signs of you know GDP has picked up a bit um interest rates generally around the world looked like they could be coming down um and the share prices start to move up like they have large cap and that you know that seats are into small cap and midcap guess what m&a acquirers then start to come out of the blocks they feel they feel that the economy is strer and then they see share prices on move and they want to get it get in there and do deals so m&a will be significant and we’ve had our share of it um this year you know there’s been an approach for Wood Group um and then today in an approach for keyword system so m&a will be a feature as to your other point Capital allocation you know it is very important and I think in the last few years companies have got better at it or woken up to it more so that we’ve had discussions and part the discussions that we had with shell the other day were about um Capital allocation you know these are businesses that are buying back shares but also they’re becoming better at the ways that they spend their money so they’re becoming better at that Capital allocation in terms of of investment um shell seem to want to be uh much more careful about Capital spending in fact they probably want to become more asset light in what they do to get higher Returns on their invested Capital so that’s one of the reasons why we think you know the Returns on invested Capital should be improving for these businesses and then there’s lots of businesses that have been buying back their shares you know in many ways rather than then go down the path of m&a when their Shares are so cheap we do encourage them to be buying back their Equity um and sometimes that engagement with companies um really helps encourage them to do it and we are sometimes disbaled with other companies who don’t want to do it because they see it as an admission of failure that if they can’t think of things to invest in they think it’s a failure to be buying back their own shares but actually we don’t feel that we feel that when Shares are very very cheap and while they’ve got free cash flow being generated you know you know why what’s better than buying back your own stock that you know so well on a very cheap valuation no interesting points then and see our kind of standard final question um which we ask all um all interviewees is is one that kind of asked you for your highest conviction area at the moment and and some people have answered this in different ways so you don’t have necessarily choose your your favorite single stock it could be a kind of area of investment but I wondered if there was if there was one particular area that you’d highlight from the portfolio at the moment yeah I mean it’s got to be sport companies um and my spirit of doing sport cap goes back a very very long way back 19903 and you know when you were getting lots of companies on single digit PS double digit free cash flow yields um with you know the ability to com bound out into big markets it’s very very compelling um you know there’ll be businesses you know in areas like you know the media space um you know companies that over the years had built up amazing data platforms um are are very compelling for the long term you know something i’ believeable AG is more expensive but something like you’s come back a bit next1 15 is is a pretty cheap business we sh we saw future group that came out with results which were a bit better than expected and their shares were quite strongly the other but there still a single digit PE and double digit free cash low yield so the SL cap sector um is an area I think which is very compelling it’s the best way to to deal with small cat really is to have a sort of portfolio of stocks um but within that portfolio you can get super returns particular at these sort of moments when things are very cheap and then the market appears to be picking up for them not only in terms of sort of interest in an m&a sense but also just purely in sort of GDP sense for these businesses um and those businesses will have a long way to travel in share price terms certainly seen a a kind of initial move in some of these names but but certainly lots of lots of value still out there for sure and an I really appreciate your time today it’s been been great to to to chat with you thank thank you again really enjoyed that thanks very much for having me on thank you for listening to the investor insights podcast hosted by kilick and Co you can get in contact using our podcast email address investor insites at kick.com for more information on any of the topics discussed or for further details on the services offered by KCK and cod this podcast is not personal advice the content is intended for educational purposes only and is not investment research or a recommendation to buy or sell any Financial instrument or product or to adopt any investment strategy the value of your Investments can rise as well as fall and you could get back less than you invested past performance is not a guide to Future performance the Investments referred to in this podcast may not be suitable for all investors and you should seek advice from a qualified investment advisor kilen Co is authorized and regulated by the financial conduct Authority the FCA