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Mar 14, 2024

How Liontrust manages sustainable investment

Fund manager talks thematic investment, the importance of mid-caps and focus on the long term

Liontrust was launched in 1995 and listed on the London Stock Exchange in 1999. Today, there are seven teams that invest in global equities, sustainable investment, global fixed income and multi-asset, and a third of Liontrust’s assets under management are in sustainable investment.

CFA charterholder Chris Foster joined the firm in April 2017 as part of the acquisition of Alliance Trust Investments. He co-manages the Liontrust GF Sustainable Future US Growth Fund, which launched in July 2023, with Simon Clements and Peter Michaelis. It is an Article 9 fund and focuses on 35-55 stocks.

In recent years, Liontrust has made a number of acquisitions such as Majedie and Neptune. How are acquisitions integrated?

Each team is very much independent from the rest of the organization. Our team joined in April 2017 and has been kept separate from those other acquisitions. We don’t have a CIO and we don’t have a house view. It’s been very seamless for us: the support services we get from Liontrust, the sales, marketing, compliance, risk, performance and distribution are all unchanged.

You have offices in Edinburgh and Luxembourg. Are fund managers based there?

The fixed-income teams are based in Edinburgh.

Your fund currently has assets under investment of around $100 mn. Do you have a target for total assets under investment?

We don’t have a firm target, but you want the fund to be at a scale where it is self-supporting. The fund launched in July 2023 and had a pretty good start. The best time to raise money also tends to be the hardest time to raise money: you want to raise assets following a period of difficult performance and when sentiment is negative.

Can you describe your investment style?

I would say it is quality growth and imbedded sustainability, which leads us to companies exposed to structural growth. We believe the world is becoming cleaner, healthier and safer, and we want to own businesses that are helping the world make that transition.

There are three mega-trends we invest behind: better resource efficiency, improved health and greater safety & resilience. There are 20 themes within these three mega-trends. Our investment process looks to find sustainable companies that we believe have better growth prospects and are more resilient than the market gives them credit for. We use this underappreciated advantage to deliver outperformance.

Which screens do you use? 

Thematic analysis identifies companies with strong and dependable growth prospects due to alignment with our sustainability themes. It also provides ideas generation – we are looking for companies that have tailwinds, companies in a growing rather than shrinking sector. We look at percentages of revenues: at least half of a business must have exposure to one of our sustainable investment themes.

Sustainability analysis focuses on companies with excellent management and core products or services that contribute to society or the environment. We have been rating companies on our proprietary matrix rating for more than 20 years and we focus on the key ESG issues most relevant to the company and industry in question.

Analysis of business fundamentals selects only those companies positioned to deliver high returns on equity. We use cashflow return on capital at a portfolio level. At the end of December 2023, it was 33.4 percent for the portfolio vs 27 percent for the benchmark.

Valuation analysis determines that the shares of the company should be worth significantly more in the future. We are looking for at least a 10 percent annual absolute return in a company over a period of five years for it to be eligible for the fund.

We believe we have two major competitive advantages. Firstly, we fully integrate sustainable analysis rather than outsource this process. Secondly, our time horizon is five years. For US equities, in the 1970s, the average holding period for stocks was more than five years. By 2022, that had fallen to nine months. We see this as an opportunity as there are so many market participants focusing on the next quarter, whereas our job is to evaluate what a company will be worth in five years. We zoom out from near-term noise and market stress and focus on the long-term potential in the businesses we invest in.

What is your average market cap and average holding period? 

The top 50 stocks in the MSCI make up half the index. We held only six of those at launch so we will have differentiated results from the index. To be active managers, you must invest differently, otherwise you will just get benchmark returns.

The great thing about the timing of our launch in July 2023 was that mid-caps and small-caps had been left behind by the mega-caps and that’s where we see the valuation opportunities. We have a mid-cap bias, with around 36 percent of the fund invested in companies with less than $30 bn market cap. Our average holding period is five years.

As you are an Article 9 fund, which sectors can’t you invest in? 

Companies with exposure to diesel engines, coal and oil, natural gas, tobacco, aerospace & defense, gambling and nuclear.

How do you split sectors?

Every fund manager is also an analyst, so each sub-theme has an analyst covering it. For example, I cover ‘saving for the future’, which is all about the savings gap, so I cover Charles Schwab (held in the US and global funds), Avanza, which is a Swedish online bank and AJ Bell, which is held in the UK funds.

We have a collegiate approach. The team was founded in 2001 and there are some long-tenured members. We meet each Friday morning to go through the sustainability analysis of a company, a new idea or an annual refresh. We refresh every holding in the portfolio at least once a year.

If a company is presented on a Friday for sustainability analysis, on a Tuesday we collectively go through the business fundamentals and the valuation. But the fund managers make the final decision about how a stock fits into the portfolio (size of position, timing of purchase, and so on).

We are back in the office three days a week minimum as there are tangible benefits to that, particularly as we have been reinvesting in the team in recent years and have hired three new analysts on both the equity side and fixed-income side over the past three years.

Can you discuss some of the larger holdings in your portfolio?

Thermo Fisher Scientific is 4.2 percent of the fund. It is exposed to ‘enabling innovation in healthcare’, which is 13 percent of the fund and our biggest theme. Plus, there’s lots of valuation excitement as the healthcare sector has been hit by events such as normalization of the pandemic, weakness from China and finally, the weight loss drugs that spooked the sector.

Thermo Fisher is a life science tools company, providing analytic instruments and services to laboratories. It is the ‘picks and shovels’ of innovation in healthcare – a way of getting exposure to an exciting, growing area of the economy without having to pick a life-changing drug. We also own Waters and Agilent. If you are long-term and bullish on innovation and the spend from laboratories and pharmaceutical companies, these companies are a fantastic way to get exposure to that theme.

American Tower Corporation is 3.4 percent of the fund. It owns more than 220,000 wireless communications and broadcast towers worldwide but, as the name suggests, the US is its biggest geography. These towers are used by telecoms companies as the backbone infrastructure for their mobile networks. It is clearly a huge area of growth in terms of the demand for connectivity such as 5G and the internet of things.

Markel Group is 3.3 percent of the fund. One of the benefits of investing in the US is the depth and size of the market. Markel’s market cap is $20 bn but it’s a company that not everyone is aware of. Its predominant business is to provide specialist/super-niche insurance – for example, for musical festivals. This plays into our ‘insuring a sustainable future’ theme given the safety net that insurance provides (no need for large cash reserves).

Palo Alto Networks would be a much larger position, but the valuation holds us back. We’ve held it since 2017/2018 in the global fund and it has been an incredible investment. We believe it has become a platform in much the same way Microsoft has. Cyber-security is so difficult/complex for companies to understand/manage and Palo Alto has become the platform to outsource that business to.

‘Enhancing digital security’ is the theme Palo Alto plays into, and we think that’s a huge opportunity as the world becomes increasingly digital and the attack surface broadens: desktops, laptops, mobile phones, printers, CCTV, and so on. Add AI and the complications posed by a cyber-security risk and the growth is unlikely to abate, so it is an exciting area to be invested in.

Do you like to meet management before you buy a stock? 

We try to but it is not always practical. We really like to understand the culture of an organization and believe this is hugely overlooked by the market. It is difficult to put culture into a cell in Excel and hard to model. If you are going to own a company for five, 10 or 15 years, culture really matters. You get a good feel for the culture by visiting HQ and also from speaking to people who used to work there.

What is your preferred way to meet management? 

Generally, a one-on-one at HQ as people are more relaxed and you can get a tour. Edwards Lifesciences is a holding we visited in December; it makes heart-valve replacements. Following the visit we now have a better understanding of what it’s like to work there and the manufacturing process, which is largely by hand. You don’t tend to get such insights from attending a large conference.

Why should companies meet you? 

We have a five-year time horizon and do a lot of work before we make an investment. We are patient and supportive of long-term actions the management team may make vs potential short-term difficult decisions to cement the future. Our meetings are very much focused on the long-term potential of the business and, where possible, we try to help the company improve its ESG disclosure.

Gill Newton

Gill Newton

Gill Newton of Phoenix IR
Partner at Phoenix-IR