Liontrust fund outflows raise concerns

But now, with the fund experiencing choppier waters, its future direction has been called into question by some experts-though Liontrust states it has the right processes when it comes to managing liquidity.

This makes the situation all the more remarkable, given that despite the company's expansion via an acquisition spree, taking it into multi-asset and sustainable investments, the Special Situations fund has continued to account for more than 20 per cent of the business's total assets. 

I can imagine the fund could face a liquidity crisis in the case of accelerated redemptions or adverse market conditions.Albert Saporta

The Liontrust Special Situations fund has exposure to large, mid and small caps.

The problem speculated on by one adviser, who wants to remain anonymous, may be that, if in response to outflows, the managers sell the larger holdings and clients are left with a fund with a much greater exposure to small caps. But there is no evidence of this happening with existing or future outflows. Liontrust say the mix of large mid and small caps has not changed, and a separate, dedicated team work on liquidity management.

It is worth noting that the management team also operates a dedicated smaller companies fund for clients with that as a preference. 

Outflows

Liontrust Special Situations peaked at £6.5bn in August 2021, and is presently £3.8bn in size. October was the worst month for outflows in more than three years, at £148mn.

As the table (below) shows, there have only been four months in the past three years where outflows resulting from clients withdrawing cash have not exceeded inflows.  

In a letter to Liontrust chief executive John Ions, the French billionaire investor Albert Saporta – a former activist shareholder in GAM, a fund house Liontrust unsuccessfully bid for – wrote: “I can imagine the fund could face a liquidity crisis in the case of accelerated redemptions or adverse market conditions.

"According to Bloomberg, the fund has 56 positions ranging in size from £179m to £8m.

"However, I was shocked to see that only seven of them, representing about 24 per cent of [the assets], could be deemed as liquid, that is, the position size represented between one and seven days of trading assuming 30 per cent of the average daily volume (ADV).”

The letter was published on the NewGam website. NewGam is an investor group that controls 9.6 per cent of GAM Holding AG.

ADV is the standard measure for assessing liquidity and means the proportion of the daily trading in a stock that would be taken up by just one seller; so the exercise is conducted on the basis of Liontrust’s exiting a stock in the Special Situations fund over the course of one week, and its selling position representing 30 per cent of the daily trading in a stock. 

The analysis is based on the premise that if one seller represents more than 30 per cent of the volume, it could cause the price of the share in question to fall markedly. 

Saporta conducted the liquidity analysis using Bloomberg data when the fund was £4.5bn in size, and it has shrunk since then.

Liontrust regularly trades in volumes which represent many multiples of average daily volume in our small cap equities. Liontrust spokesperson

Of course, at the time he conducted the analysis, Saporta was engaged in a business dispute with Liontrust, so in order to stress test the methodology he used, three other investors were approached by FTAdviser for their view on the methodology, without disclosing to them the name of the fund. 

They found the 30 per cent ADV criteria to be valid, or indeed slightly more optimistic than the percentage they would use on the funds they personally run for their own clients. 

Liontrust has, however, defended the liquidity and suitability of its fund.

On the question of suitability, Liontrust has told FTAdviser that, even as the fund managers have been selling assets in order to meet redemption requests, the proportion of the fund invested in small caps has not actually fallen, which should mean the suitability element does not presently arise. 

Number crunching 

According to the fund's factsheet on FE Analytics, all of the top 10 holdings in the Liontrust Special Situations fund are large cap, mostly FTSE 100 shares.

These would be expected to have ample liquidity and be capable of being sold quickly in order to meet redemption requests, but this may not be where advisers and their clients should be focused, according to several experts consulted by FTAdviser.

One investor says: “The thing you have to do when looking at the liquidity is the liquidity of each stock, not of the portfolio as a whole.

"This is because, while a fund could have lots of liquidity from selling the large caps, doing so would leave clients invested in a fund which is solely small and mid caps, and that may not be what the client thought they were invested in, or want to be invested in.” 

It is no mystery that UK small and mid-cap stocks have been in a funk for some time.Albert Saporta

A representative of Liontrust has confirmed that they do conduct analysis of the liquidity of the Special Situations fund at the stock, rather than the portfolio, level, and “maintains the balance of large and small caps held within the portfolio".

The representative adds: “Liontrust has robust and independent controls and monitoring in place, with a segregated risk team overseeing liquidity and other risks across all of our funds.

"The risk team regularly compares the liquidity of underlying assets to a fund’s redemption profile under normal market activity and under several adverse scenarios, including fund manager departures, large single redemptions and stressed market conditions."

Liontrust says that examining the liquidity across a range of different plausible scenarios is of more value than a headline analysis using ADV. 

"Liontrust’s experienced centralised trading team also plays a critical role. Strong relationships with the sell side are key to discovering the other side of a trade for small caps.

"It is important to recognise the inherent limitations of ADV-based liquidity models for smaller companies.

"Liontrust regularly trades in volumes which represent many multiples of average daily volume in our small cap equities.”

The spokesperson also highlighted the following:

• The Liontrust Special Situations Fund does not invest in any unquoted stocks.
• All of the companies in the portfolio are listed on the London Stock Exchange or Alternative Investment Market.
• The fund is committed to holding between 20-30 per cent of net asset value in smaller companies and AIM (31/10/23: 23 per cent).
• Some 73.2 per cent of the fund’s assets are invested in FTSE350 stocks; within that, 45.7 per cent of fund assets are currently invested in highly liquid FTSE100 companies.
• Cash levels are typically between 3-7 per cent.

But Saporta says in his note: “If one assumed that the portfolio managers would want to account for 20-30 per cent of the average daily volume, some positions would take years to exit without destroying the share prices of their own holdings.

"The [then 6.4 per cent] cash allocation is certainly not a big enough cushion. It is no mystery that UK small and mid-cap stocks have been in a funk for some time with liquidity completely drying up.

"If redemptions continue at the same rate, or even accelerate in the case of a market crash, the portfolio managers will find it impossible to sell the illiquid positions in the same pro-rata of the redemptions than the larger market cap stocks held by the fund so that the proportion of illiquid securities will automatically increase.

"Moreover, in such cases, speculators and investors will  want to front-run the fund, shorting those illiquid securities and prompting further losses at the funds.”  

Those comments were made prior to the most recent outflows, of more than £100mn a month in both September and October. 

Sum of its parts?

"Front running”, as Saporta references above, occurs when investors, aware of the redemptions from a fund potentially forcing the sale of small caps, may decide to short sell the stock in question as they are aware a big seller is in the market and so the price will fall.

Or, as one of the professional investors mentioned above commented to FTAdviser, without knowing the name of the fund in this article: "If I see large blocks of stock coming onto my screen as being for sale, I will know it's coming from a forced seller, and I will try to push the price down – everyone in the market would." 

Liontrust states that the potential for front running to adversely impact the prices they can sell stocks at is one of the factors considered by its dedicated liquidity risk team when measuring the liquidity of the fund. 

The Liontrust Special Situations fund has lost 1 per cent over the past year, underperforming the sector average return of 2 per cent in the same time period.

On a five-year basis, it has returned 23 per cent, compared with 19 per cent for the average fund in the IA UK All Companies sector in the same time period. 

Darius McDermott, investment adviser to the VT Chelsea multi-manager fund range, is a long-time investor in the Liontrust Special Situations fund. 

He says: “The manager Anthony Cross is very long established, and the fund is run by a large and growing team.

"They probably mean something else by Special Situations than other managers do, but I would say they have a lot of experience in smaller-company investing."

Ben Yearsley, investment director at Fairview Consulting, says: "I do use the fund, but more sparingly than I did a few years ago due to the size of the fund, though its performance has been okay in tough market conditions."  

David Thorpe is investment editor at FTAdviser