This year marks the 10th anniversary of two of the most significant enhancements to the Cashflow Solution investment process, which was the introduction of Secondary Scores and Market Regime Indicators.

By Samantha Gleave and James Inglis-Jones, co-managers of the Liontrust GF European Strategic Equity Fund

Our investment process, the Cashflow Solution, was established in 2006 based on the core belief that cash flow is the single most important determinant of shareholder returns. The basic idea is that companies run by conservative managers focused on and delivering cash flow perform significantly better than companies run by aggressive company managers making large cash investments today to chase over-ambitious future growth targets.

We rank the universe of European stocks based on their cash flow attractions. The top 20 percent form our Cashflow Champions watchlist from which we choose investments for our portfolios following in-depth forensic analysis of balance sheets and cash flow statements.

Broadly speaking, this top 20 percent contains companies that are cheaper than the market with cash returns that are better than the market.

Evolution, not Revolution

When we carried out an in-depth review of our investment process throughout 2013 – paying close attention to how it had historically been applied in practice – it became clear that we could make improvements that would improve both the scale and consistency of our returns.

The single most impactful change resulting from this research was the introduction in 2014 of secondary scores. This has proved essential in helping us refine our Cashflow Champions list to the final selections for our portfolios. While we have carried out numerous research projects on the construction of our secondary scores since 2014, they have remained largely unchanged since their introduction.

Further Filter

We categorize companies’ cash flow profiles as possessing Momentum, Cash Return, Recovering Value or Contrarian Value appeal. We call these categories our secondary scores as they act as a further filter to our primary cash flow screen.

When we implemented our secondary scores to stock selection, we also introduced some indicators to guide us on stock selection in the context of the current market cycle. We call these our market regime indicators and they are unique to us.

Fairly Balanced

This combination of secondary scores and macro indicators has been essential in giving our cash flow investment process style flexibility and ensuring that portfolios are positioned to reflect prevailing market conditions. Our market regime indicators guide us on both the outlook for markets and style positioning.

The average style exposure has been fairly balanced since the secondary scores were launched 10 years ago. However, this does not give much of an insight into the extent to which we have varied the style exposure over time to reflect the signals from our market regime indicators.

Heavy Emphasis

The portfolio tilt towards value, core, and growth has changed significantly over the last 10 years. For the first five years or so, cash-generative companies with growth characteristics had been a mainstay in the portfolio, with exposure of around 50 percent.

But as stock markets tumbled at the start of 2020, precipitated by the threat of COVID, all our market regime indicators were signaling the need to reshape our portfolios with a heavy emphasis on our Contrarian Value secondary score. This shift was captured by the Morningstar categories as a pronounced increase in Value as the market impact of COVID unfolded from around 10 percent in mid-2019 to around 50 percent at points during 2022.

Ongoing Process Improvements

We have been very pleased with how the secondary scores have enhanced the Cashflow Solution process, but this is just one element of a rigorous, in-depth investment process that we continue to improve year on year.

While 2024 will see us pass a rewarding milestone in the form of the 10th anniversary of our secondary scores, our investment focus remains resolutely forward-looking – seeking to bring the accrued analytical power of our investment process to bear on portfolios as we position them for the current market environment.

We are not complacent; we recognize that for good returns to persist we need constantly to be on the lookout for ways in which we can improve our cash flow process.

Information for Swiss Investors.

This is an advertising document.
Note: This is marketing information. Investment in investment funds is subject to market risks. Past performance results are no indication of future results. Especially performance results referring to a period of less than twelve months are no reliable indicator for future results due to the short comparison period. Issuance and redemption commissions are not included in the performance figures. The domicile of the Fund is Ireland. For interested parties, the Statues, the Prospectus, the Key Investor Information Document as well as the Annual Reports and, if applicable, the Semi-Annual Reports may be obtained free of charge from the Swiss Representative: ACOLIN Fund Services AG, Leutschenbachstrasse 50, CH-8050 Zurich, Switzerland and the Paying Agent: Banque Cantonale Vaudoise, Place St-François 14, CH-1003 Lausanne, Switzerland.