Fund managers like Liontrust Asset Management make great investments in a bull market

Liontrust Asset Management. LIO . Latest 1200p . MV: £606m . Employees: 123  Next figures due: 18 June

Since the low point in 2009 shares in fund management group. Liontrust Asset Management (LIO), have risen roughly ninefold. Over the same period one proxy for UK shares, the FT 30 Share index has roughly doubled. Why have LIO shares done so much better?

I would suggest three reasons. First, asset managers typically outperform the stock markets in which they invest, both up and down, because they have great operational leverage. When assets become more valuable, as they do in a bull market, assets under management go up generating higher fees but costs move up more slowly because you don’t need more fund managers or other staff just because the assets have become more valuable. This effect is reinforced because rising markets make fund managers look good, which attracts new money into the funds. As we shall see later this combined effect can lead to a spectacular surge in funds under managements (AUM), which is the key metric driving growth in sales and profits at fund management businesses.

Secondly, Liontrust makes a point of investing in high quality shares from around the world. In the current circumstances this means it is heavily invested in US shares, which have been outperforming shares in most other markets including the UK.

Third, Liontrust, since 2009 has been very well managed both as a business and as a manager of funds. Prior to 2009, exacerbated by the collapse in global stock markets triggered by the financial crisis, Liontrust had been in an increasingly parlous state. In 2009 Adrian Collins, a highly experienced administrator of fund management businesses, arrived as chairman, closely followed in 2010 by John Ions. These two talented individuals replaced the previous top management and have transformed the business.

All these changes together have had a seismic impact on AUM, which has climbed from £1.49bn in 2010 to a latest figure of £19.1bn, based on a trading update issued by the group yesterday, 9 January. The acquisition of Neptune Investment Management in October 2019 added £2.7bn to funds under management.

Although Adrian Collins has recently retired business at Liontrust is booming as evidenced by the quote below from the trading update.

““Liontrust has continued to generate significant growth. We have delivered net inflows of £836m over the past three months and £2.2bn since the start of the financial year on 1 April 2019. Net inflows for the past nine months are almost double those of the same period last year. These sales in combination with performance, market movements and the acquisition of Neptune Investment Management on 1 October 2019 have led to Liontrust’s AuM now exceeding £19bn. A year ago, our AuM was £11.2bn. The addition of the Global Equity team from Neptune has been well received and we have started marketing the managers and their range of funds. The diversification they provide across global equities and emerging markets is offering opportunities to expand our client base. The funds managed by the Sustainable Investment team continue to experience strong flows, with its AuM increasing to over £5bn. While the retail market has primarily driven these sales, there is growing interest from institutional investors and we are optimistic about increasing flows from non-UK investors.”

The company is also justifiably optimistic on the outlook, especially for its exciting sustainable investment business, which is clearly catching the imagination of investors.

“As we enter a new decade, we anticipate the strong momentum behind sustainable investment at the end of the last will accelerate. All stakeholders, whether they be individuals, corporates or governments, have an obligation to consider and improve the environmental and social outcomes of their investments, which are best achieved by active investment managers. With Liontrust’s breadth and experience in both fixed income and equities, we are ideally positioned to benefit from this.”

Fund management businesses can grow at an astonishing rate given favourable background conditions as powerfully demonstrated by Liontrust’s own performance over the last decade. If the new decade remains favourable and there are many indications that it will Liontrust could continue to dramatically outperform the market averages.

The shares are classic 3G and on a long-term perspective the chart looks strong suggesting that the shares are timely to buy right now.

Here is what another investment service is saying about them.

“The drawback with high quality, strong momentum shares is that the market loves these traits. So stocks like Liontrust Asset Management rarely look cheap, and that can put many investors off. Only with hindsight could you say they were a bargain. You can think of these shares as being the stock market’s High Flyers. So what are the common features of stocks like Liontrust Asset Management and where can you find more companies that have them?

To start with, High Flyers are very distinctive. They are good quality, both in terms of their franchise and financial strength. This tends to show up in high profitability and strong industry leading margins. They’re stable, growing and often have accelerating sales and earnings. They also have strong and improving financial histories and no signs of accountancy or bankruptcy risk.

Liontrust Asset Management is a small cap stock in the Investment Management & Fund Operators industry. One of its stand out quality metrics is its 5-year Return on Capital Employed, which is a solid 27.9pc. Good, double-digit ROCEs are a pointer to companies that can grow very profitably.

High Flyers also have strong momentum both in the price of their shares and their track records of earnings growth. It shows up in stocks trading close to their 52 week high prices and outperforming the market. They’ll often be beating broker estimates and getting forecast upgrades and recommendation changes.

This is true at Liontrust Asset Management, where the share price has risen by 141.1pc over the past five years. This positive momentum has continued over the past year – Liontrust Asset Management’s 1-year relative price strength is 7.46pc. This kind of momentum can be a powerful factor and often persists when the shares look expensive.

The drawback with high quality, strong momentum shares is that the market loves these traits. So stocks like Liontrust Asset Management rarely look cheap, and that can put many investors off. Only with hindsight could you say they were a bargain.”

No surprise that I love high flying stocks, which often look expensive but prove to be cheap. Liontrust looks a good example. I haven’t got any projections for sales, earnings and dividends. Most likely this is because earnings for fund managers are ridiculously hard to predict. Everything depends on unknowable variables like stock market movements and fund inflows. The track record is spectacular and could well continue well into the future. Success breeds success.

Something new can be a big driver of share price outperformance and in the case of LIO that something new could be the success of the Sustainable Investment business which is a relatively new element.

“The success of the diversification of the business has been demonstrated by the Sustainable Investment team. The AuM of the team has nearly doubled since we acquired them in April 2017 and, according to the Pridham Report, we are second for gross and total net ESG sales in the UK for the third quarter of 2019. ESG is an increasingly competitive area for asset managers because of the growing demand for this way of investing. The greater focus on and analysis of sustainable investment, with issues such as greenwashing gaining increased prominence, will lead to investors becoming more discerning about who they entrust their money with in the future. We are well positioned to benefit from this given the credibility, experience, 18-year track record and rigorous process of the Liontrust Sustainable team and the brand we have built for our proposition. ”

Environmental, Social, and Governance (ESG) refers to the three central factors in measuring the sustainability and societal impact of an investment in a company or business. These criteria help to better determine the future financial performance of companies (return and risk).

It is easy to see how ESG could become increasingly important for investors generally and for LIO particularly.

Liontrust shares do not look especially expensive to me. If I was rich enough to buy the whole company I would get over £19bn of assets under management, an increasingly highly regarded brand at a time when rivals like the Woodford funds have had a terrible time, a superlative team of fund managers and a talented top management team led by a star CEO. All that for £600m looks good value to me, if not an absolute steal. I also like the simplicity of their investment approach. Fund managers have great freedom of action but this is built around a disciplined approach to investing and a focus on building portfolios of the world’s highest quality shares and bonds. That sounds both sensible and effective and is validated by a superb track record.