Barely two years ago the group looked ready to implode, but inflows are reviving under a new chief executive and Liontrust Income is outperforming in the hands of two managers in Devon.
It’s a nightmare for an asset management company. Its key fund managers quit, and its share price collapses as worried investors head for the doors.
No, this isn’t about Gartmore. This was Liontrust nearly two years ago. And it was irony indeed that last week, on the same day that Roger Guy quit Gartmore, Liontrust was holding a swanky reception in London’s Savoy Hotel to relaunch itself.
It was in January 2009 that Jeremy Lang and William Pattisson, responsible for 90% of Liontrust’s assets, resigned and promptly sent the share price tumbling 33% in a single day. For a while it looked as if the group might implode altogether. But the share price has stabilised and the third quarter of 2010 saw the first net inflow of funds, albeit small, since Lang and Pattisson quit. (article continues below)
Liontrust manages about £1.2 billion, far below the halcyon days of 2007 when funds under management were £5.5 billion. But the new chief executive, John Ions, reckons that Liontrust will roar again. And who’s going to help him do it? Two men down in Devon who refuse to visit any of the companies they invest in. And who think that markets may be somewhat overpriced at the moment.
Gary West and James Inglis-Jones, who took over Liontrust First Income from Lang and Pattisson (it was renamed Income in September) are not standard-issue fund managers. They are both as cool and detached as the process they use to manage money, which they call the “Cashflow Solution”.
It’s a system they developed for the European funds they have managed for Liontrust since 2006.
”Managers can fall in love with stocks and the people who run them. We don’t invest our own egos into the process”
Cashflow Solution is the duo’s forensic accounting method which they say leads them into prudently managed stocks with high cash flows and sustainable yields.
“No other managers have such a myopic interest in cash flow as we do,” says Inglis-Jones. And no other managers are doing what these two are doing – because, West says, “it’s incredibly dull”. “James and I go to work on the accounts of a company and it’s incredibly dry. But we get enormous satisfaction from it. There’s no sex and violence, we don’t visit companies, and we don’t kick the tyres.”
Non-engagement doesn’t just help you gain a different perspective, it’s absolutely essential, says West. “You never find added value from meeting company managers. These people are very smooth and persuasive. We deliberately ignore that contact. Other managers are too easily swept up in growth stories. They can fall in love with stocks and the people who run them. We don’t invest our own egos into the process.”
It’s the same with the output from all those incredibly highly-paid analysts working for investment banks. “Most sell-side analysis is worthless,” he says. Behavioural psychology plays a large part in their approach. “People often deal with information emotionally and irrationally, making their forecasts unreliable.”
The pair like to spend time looking at profit forecasts made by company managements and then pick them to pieces. Managers make profit forecasts and investment bank analysts support them. This, say the duo, creates profit expectations that are unsustainable. These errors, says Inglis-Jones, are “predictable and identifiable and create our investment opportunities”.
“We look for companies which are cognisant of forecasting risk and focus on cash generation instead,” adds Inglis-Jones. “In our hedge fund we are looking for companies that are doing the opposite – that are optimistic about profits and are investing their cash. But companies that have grandiose expansion plans invariably disappoint the market.”
But enough of the theory. Does it work in practice? Over three years, Liontrust Income is fourth quartile – ranked 82nd out of 95 funds in the UK Equity Income sector.
But three years ago, West and Inglis-Jones weren’t running the fund. Figures from Liontrust show that since the present managers took over on March 25, 2009, the fund is ahead 55.7% compared with the 46.7% sector average and a 53.5% gain in the FTSE All-Share over the same period.
What about the other funds they manage? Liontrust European Growth, their responsibility since 2006, is top quartile over one and three years, while their Pan-European fund (a Luxembourg Sicav) is also a top performer.
Their European long-short fund had a fabulous 2008, but their more recently launched European Absolute Return fund has yet to impress.
So the system is working, although maybe it will take time before the magic dust of Cashflow Solution works through in the Income fund.
West acknowledges that the system falls down in sectors such as biotech and oil and gas exploration, where the cash signals can be negative yet the companies can become highly cash generative. But he insists that the process worked well in steering them away from financials during the crisis.
“We found in 2007 that an increased number of companies in the financial sector were behaving badly, particularly the Irish banks, which were coming up again and again as short ideas,” says West. “They were growing their assets incredibly fast, and seemed to have lost all reasonableness.”
Cashflow Solution works well at both the top and bottom of the cycle, where it’s best at exploiting extreme behaviour.
It even spots fraud long before the regulators or police do. West points to the collapse of a start-up German aero engine maker, which was simply not a genuine business. Their system detected an almost total lack of real cash flow. “The analysts didn’t look beyond the CEO’s forecasts. It eventually had to restate its accounts and it imploded.”
West concedes their system doesn’t get it right all the time. “We get a lot wrong. We identify a lot of companies where it doesn’t work. But we expect the process to work on average.” He says that France is, peculiarly, a market where the system often fails. Stocks there sometimes don’t behave rationally, rising despite profit warnings, behaviour that he attributes to political interference.
But don’t worry, he says. It works well in Britain.