This year has seen an evolution in our outlook for the European market, from a more pessimistic stance taken over the course of 2022 to a much more constructive view in 2023. We adjust the degree of net market exposure in the fund to reflect the outlook from the Liontrust Cashflow Solution investment process.

By Samantha Gleave, manager of the Liontrust GF European Strategic Equity Fund

This exposure can vary significantly over the course of a market cycle. When our market regime indicators point to a constructive outlook for equities, the net market exposure can rise significantly and approach 100 percent, particularly if market volatility is simultaneously expected to be low.

If we are more circumspect about the market environment and believe it to be more volatile and conducive for shorting, the net exposure can fall significantly. The evolution in our outlook over the last year can be observed through the net exposure of the Fund, which has risen significantly during 2023.

Three Reasons

At the beginning of the year, the net exposure was around 25 percent. By March, this had risen to 40 percent and by the middle of the year, the net exposure had increased to around 75 percent, where it has since remained. The reasons for the improving market outlook are threefold.

  • First, the technical assessment of the market changed significantly from a mixed picture of a rudderless market in late 2022 (after the September 2022 trough) towards a much more convincing uptrend emerging early in 2023.
  • Second, our valuation gauge highlighted that, whilst the market was not at very cheap levels, it was approximately fair value. When accompanied by an up-trending market – as seen now – this is usually a good sign for equity markets.
  • Third, the concerning signs of company mal-investment that had emerged in late 2021 and remained high over the course of 2022 waned significantly in 2023.

Constructive Sign

This is another constructive sign for markets and an indication that short strategies are unlikely to be as profitable. The Fund is currently positioned to reflect these views. The short book is comparatively small at -40 percent of NAV in response to the less conducive shorting environment, while the long book is modestly geared at 120 percent of NAV – reflecting an up-trending market that sits on valuations that are not particularly challenging.

Net exposure is therefore relatively high at around 80 percent. In this environment, we are particularly focused on those stocks with excellent momentum characteristics as identified by our proprietary secondary score system.

Invest in Value Stocks

This is an important style indicator that highlights the risk of a momentum crash, and currently, this risk is judged to be extremely low. Accordingly, we have selected long positions that have attractive momentum secondary scores whilst in the short book care has been taken to identify poor cash flow stocks with poor momentum secondary scores.

The investment process continues to highlight that value stocks should perform well. However, in the current environment, we want to invest in value stocks that also show evidence of positive momentum. The process is clear that this is not an opportunity to buy exceptionally cheap contrarian value stocks with poor momentum.

Two Key Cashflow Ratios

Instead, we have focused on the recovering value secondary score. This means investing in stocks that are not only in the top 20 percent of the European equity market as rated by key cash flow scores, but are also cheap in conventional valuation terms and showing some signs of recovery.

The Cashflow Solution process screens the European equity universe on two key cash flow ratios to create a Cashflow Champions watchlist of the top 20 percent stocks. From this, we conduct fundamental cash flow analysis to categorize stocks by a «secondary score» type: momentum, cash return, recovering value and contrarian value.

Rosy View of the Future

We tilt stock selections towards or away from these scores depending on the prevailing market regime. The size of the short book is determined by the proportion of companies with undesirable cash flow characteristics. When company managers have a rosy view of the future, the short book will be close to 100 percent of the Fund’s net asset value; when they are pessimistic, the short book will be close to 30 percent NAV.

We target expensive companies run by managers who combine over-confidence in their forecasting ability with a willingness to invest heavily to grow operating assets.

  • You can find more information about GF European Strategic Equity Fund here.

Key Risks: Past performance does not predict future returns. You may get back less than you originally invested. We recommend this Fund is held long-term (minimum period of five years) and is held as part of a diversified portfolio of investments. Overseas investments may carry a higher currency risk.

They are valued by reference to their local currency which may move up or down when compared to the currency of the Fund. This Fund may have a concentrated portfolio, that is hold a limited number of investments. If one of these investments falls in value, this can have a greater impact on the Fund's value than if it held a larger number of investments.

As the Fund is primarily exposed to smaller companies, there may be liquidity constraints from time to time, that is in certain circumstances, the fund may not be able to sell a position for full value or at all in the short term. This may affect performance and could cause the fund to defer or suspend redemptions of its shares.

In addition, the spread between the price you buy and sell units will reflect the less liquid nature of the underlying holdings. Outside of normal conditions, the Fund may hold higher levels of cash which may be deposited with several credit counterparties (for example given international banks).

A credit risk arises should one or more of these counterparties be unable to return the deposited cash. Counterparty Risk: any derivative contract, including FX hedging, may be at risk if the counterparty fails. The issue of units/shares in Liontrust Funds may be subject to an initial charge, which will have an impact on the realizable value of the investment, particularly in the short term.

Disclaimer: This article is issued by Liontrust Fund Partners LLP (2 Savoy Court, London WC2R 0EZ), authorized and regulated in the UK by the Financial Conduct Authority (FRN 518165) to undertake regulated investment business. It should not be construed as advice for investment in any product or security mentioned, an offer to buy or sell units/shares of Funds mentioned, or a solicitation to purchase securities in any company or investment product. This information and analysis is believed to be accurate at the time of publication, but is subject to change without notice. Whilst care has been taken in compiling the content, no representation or warranty is given, whether express or implied, by Liontrust as to its accuracy or completeness, including for external sources (which may have been used) which have not been verified. This is a marketing communication. Before making an investment, you should read the relevant Prospectus and the Key Investor Information Document (KIID) and/or PRIIP/KID, which provide full product details including investment charges and risks. These documents can be obtained, free of charge, from www.liontrust.co.uk or direct from Liontrust. If you are not a professional investor, please consult a regulated financial adviser regarding the suitability of such an investment for you and your personal circumstances.