It’s the day of the referendum. I’m interviewing the co-manager of a top-performing European fund, Liontrust European Growth, and the calmness exuded by Samantha Gleave belies the storm about to break over the UK. Is she briefing me on the likely impact on equities? The perils of Britain quitting the EU? The view from the European heartlands? No at all; instead she talks about cashflow, cashflow, and cashflow. Brexit doesn’t get a look in.
Funds such as Gleave’s are the type that pay no attention to day-to-day market noise, even events as shouty as the EU referendum and its dramatic aftermath. The media whipped the country into a frenzy over the referendum – and continues to do so – but for Gleave and co-manager James Inglis-Jones, it was never that important.
Their focus is on free cashflow yield. “We are interested in companies with sustainable cashflow, as cashflow is the lifeblood of any business. It is the main determinant of performance and dividends. It is why we focus exclusively on corporate cashflow,” says Gleave.
Every year Gleave and Inglis-Jones run a detailed cashflow analysis of European stocks, examining cash return on capital and free cashflow yield. Once their screening is complete, they are left with just 200 stocks and from that they select their portfolio of 30-50 shares. It’s as much a sell discipline as a buy discipline; if an existing stock doesn’t meet the requirements of the screen, no matter how well it has performed, it gets booted out. Euronext, the exchange company, is one that recently got pushed out by the screening, and it’s interesting how in recent months it has underperformed, not helped by a 10 per cent decline since the Brexit vote.
Does the focus on cashflow work? The figures speak for themselves; currently the £30.5m Liontrust European Growth fund is in third place out of 99 funds in the Europe ex-UK sector over one year, while over three years it is also top quartile. It is one of the few European funds to be showing a healty return in the last 12 months, earning investors 19 per cent when the average fund has managed only 4 per cent.
But Gleave and Inglis-Jones attribute some of the recent outperformance to a revision they have made to the process over the past few years. The top quintile of stocks that emerge after their screening are now categorised into four different pots. The first is ones that show the best growth in earnings. The second have the most stable cash retuns, while the third is ‘recovering value stocks’. These are companies that are showing signs of becoming more disciplined about capital allocation and are taking a more controlled approach to how they spend money. Finally, the fourth pot is for contrarian value companies.
You might ask how contrarian value companies can possibly meet a screening process that looks for high quality cashflows. But Gleave says that although these stocks may have poor cashflow, when measured against their depressed share values it can still look attractive. She cites energy stocks as an example.
The four-pot categorisation process has helped the fund avoid simply being a dull portfolio of mature large caps that are throwing off cash. “Historically, there was a bias in the process towards high quality and high return on equity companies. When we introduced the four categories as a secondary screen, we were able to pick the best growth and value stocks,” says Gleave.
Turnover in the portfolio, currently 47-strong, is around 30-50 per cent, partly because the duo promise never to veer off their discipline. If the stock is not meeting the screen, it gets the boot. There is no room for emotion in portfolio construction, says Gleave. What’s more if you run such a strategy and tell investors all about it, you can’t decide later to deviate.
Liontrust European Growth also has an equal weighting approach to stocks; most stock are around 2.5 per cent of the portfolio, and if they perform exceptionally well, then automatic re-balancing will see some of the holding chipped away.
Its biggest holding – and one likely to be reduced because it has grown so fast – is Pandora, the Denmark-based jewellery store chain. I speak to lots of managers who now hold Pandora, and one look at its share price chart tells you why. In 2011 it was trading at only Dkr40. Today it is on Dkr945. It has been among the most super soaraway stocks anywhere on the continent. “It has been generating a lot of top-line growth and a lot of cash. Its expansion has been self-financed and it carries very little debt,” she says.
There’s a noticeable Scandi-bias to the portfolio, not that either Gleave or Inglis-Jones show any interest in country-based allocation. They attribute it to the fact that Scandinavia, and Switzerland, have large numbers of stocks where big family shareholdings are important. “For example, we like Straumann Holdings, a Swiss dental implants maker. Thomas Straumann remains a large shareholder, and this means the company is very cash generative and focused on returning cash to shareholders.”
But what about Brexit? Surely that has had some impact on their portfolio construction? “The macro is not part of our process, although we have been more mindful of our UK exposure. We do have risk processes that tell us our exposures to various sectors, if we are very underweight or very overweight. But we are usually comfortable with that. For example, we have had a significant underweight to financials because they don’t generate enough return on capital.”
Liontrust believes that its processes will protect it from the Brexit hailstorm. Indeed, in the first full week of trading after Brexit, Liontrust European Growth gained 4.6 per cent, compared to the average gain of 3 per cent for the sector. The focus on cashflow, now more important than ever, “will provide a degree of insulation from an environment of short-term economic uncertainty and should allow the companies we are invested in to show some resilience,” she says.
47 Current number of holdings in the portfolio
£30.5m Assets in the European Growth fund
4.6% Return of the fund in the first full week of trading since Brexit
3rd Position of the fund in the sector over one year
19% Return of the fund over the past 12 months, compared to 4% for the average fund in the sector