liontrust first large cap fund achieves three-year track record despite disappointing large-cap sector returns
The Liontrust First Large Cap Fund achieved its three-year track record last week, earning manager William Pattisson an expanded share-based incentive package to stay at the group.
Alongside taking a cut of the annual management fee from his Liontrust First Large Cap Fund, Pattisson has now been offered options on 1% of the company each year for the next three years, giving him the potential for 3% ownership if he stays at Liontrust for the three-year period.
Pattisson does not try to forecast market levels but instead believes it is important to anticipate which stocks may benefit or suffer in different market conditions.
Last September, when the FTSE was at 4,600, Pattisson predicted there would be further falls and that a drop to 3,500 was a reasonable possibility due to low inflationary environment and because he felt consumer confidence had further to fall.
At the time he said that if the FTSE did fall to 3,500 it would be yielding at 4% and at this he point he would jump in as the risk reward ratio would be an attractive one on a long-term view.
Just how badly have large-cap stocks done?
In the past six months, a number of large companies have started to struggle in terms of their earnings revisions and newsflow.
If you go back six months, we held BP, Glaxo, Royal Bank of Scotland, Barclays, Legal & General and Centrica as winners and they have all disappointed over the last six months. While we still do hold these stocks, we now hold them for portfolio construction purposes and the weightings have all come down.
Despite the fact that life has been difficult for the biggest of the large-cap stocks over the past 12 months, the active money in our winners has remained fairly constant, with the balance invested in the lower half of the FTSE 100 and the mid-cap area.
Will large caps be the first to benefit from an economic recovery?
It very much depends on how the recovery is driven. If it is just a purely liquidity driven recovery with the bank cutting interest rates, the chances are the big liquid stocks will go up first, particularly the banks and insurance stocks.
If you are coming out of a recession like in 1991, the stocks that went up most were the industrial stocks. So it depends on from what level we are coming from and for what reason the recovery is taking place, so it is impossible to generalise.
This time around we are in the bizarre situation that the economy is not even in a recession and the market is behaving like we are in one. This is all due to how much the market went up in the 1990s and the valuation it reached, so we are in an unusual period in which simplistic rules of thumb are fairly useless.
In the past month, however, a lot of mid-cap industrial-related stocks have started to do very badly and the yields have gone up to levels suggesting an imminent recession.
Blue chips used to be seen as safe-havens for investors. With what has gone on with Marconi and so on, how safe are they now?
No stock is completely safe and it is our job as a fund manager to get out of stocks before there is a problem. We never held Railtrack in the fund as we felt it was too risky and we got out of Marconi at 701p nearly two years ago because we felt the risk to the business were increasing.
Will a lack of themes continue in the market?
I do not see many themes coming through for the next few months but themes can emerge very quickly and in six months things may have changed.
For instance, technology may be a strong theme within the next 12 months as companies start increasing their IT budgets.
How do you break down the stocks you invest in?
We try to break the market down into three broad, simple groups. These are companies for which prospects are getting better, which we call our winners, companies for which prospects are getting worse, which we call our losers, and companies where nothing exciting is really going on, which we call our middle ground stocks.
Statistically, we have found that 10% of the market have the characteristics of winners, a further 15% have the characteristics of losers and 75% are middle-ground stocks.
How do you screen these stocks?
There is a difference between a stock that looks quantitatively interesting to one that we really believe in.
We start off by doing a quantitative screen to identify stocks that look statistically interesting, then we do the fundamental work to decide which of those companies have prospects we really believe will keep getting better for at least another year or so.
In effect, a simple quantitative screen shows which companies have positive earnings revisions. We then look fundamentally at which of those companies will keep surprising for a meaningful period of time.
What universe of stocks does the fund cover?
The fund is a FTSE 350 product so we are not investing in small caps.
On average, we will quantitatively find around 110-120 companies that have positive earnings revision over three months and we will end up owning around 30 of those 120 as our winners.
To get down from 120 stocks to 30, we have to work out why a company is surprising and then assess whether it will keep surprising in the future. For every company, the reason will be different.
What are the things you look at to ascertain whether a company is surprising and whether it will keep surprising?
There are two basic reasons companies surprise. The first is what we call point of difference, which basically means a company is better than its peer group. If you can find companies that appear to be better in the way the business is structured and run, you can, in effect, win market share at the expense of the competition.
The second reason is change and there are three sub-categories of this: company specific changes, industry changes and long-term structural changes.
What is the breakdown of how you invest in the three categories of stocks?
Typically, 65% of the fund is invested in winners and in this category I am relatively relaxed about valuations ' they are often a bit expensive but that does not bother me.
The losers are stocks with the inverse characteristics of winners, which basically have negative revisions where we believe the characteristics will keep getting worse. We aim to hold none of these.
However for risk purposes, if they are very big stocks, we may have to have some exposure.
For example, Astra Zeneca is a big stock that we have some exposure to but we are underweight in, due to our stock controls.
The middle ground stocks, which make up 15% of the fund, are important for the portfolio as principally a risk control area and the focus is on value. This is because, as a style, value works over a longer period and, when our winners are doing badly, the cheap middle-ground stocks are there to do well and complement the struggling winners.
The 20% balance is held in stocks purely for portfolio construction purposes.
FUND MANAGER: William Pattisson
Pattisson joined Liontrust from Fleming Investment Management in June 1999.
At Flemings he became head of UK Equities in October 1998.
He joined Flemings in July 1994 and ran the Claverhouse Investment Trust among his other fund responsibilities.
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