Fund Managers’ Favourites: Conviction Stocks

VIDEO: Liontrust fund manager, Anthony Cross, discusses his three favourite small-cap stocks that possess some coveted "intangible assets"

Alanna Petroff 15 February, 2013 | 6:25PM

In the video series, "Fund Managers' Favourites", Morningstar speaks with UK-based fund managers to learn about their top investment picks. In this video, Morningstar journalist Alanna Petroff speaks with Liontrust’s Anthony Cross about his investment strategy and his three favourite buy-and-hold small-cap stocks.


Alanna Petroff: Every fund manager has their own special style of managing money, but one particular fund manager from Liontrust has stood out as being unique. That's Anthony Cross, and he specifically focuses, for the past number of years, on investing in companies with intangible assets. That investment style has stood out to our Morningstar analysts and plenty of investors across the UK. Anthony joins me now to talk about this investment style and his top equity picks.

So, Anthony thanks very much for coming in.

Anthony Cross: Good morning.

Petroff: Now let’s talk specifically about this investment style of yours - on intangible assets. Tell me how this works exactly? Lay it out for me.

Cross: Well, what we are looking for are some very clear, strong intangible assets that give companies a big barrier to competition. And there's three that we particularly like. The first is intellectual property; the second is strong distribution networks; and the third is high contracted recurring income.

So, for any of our companies to come into our fund, you've got to have at least one of those three strong intangible assets. We then also look at brands and formats and procedures and culture to get an overall picture of how a company can get its barriers to competition.

Petroff: And you're also known as being a very long-term investor as well. Can you comment a bit about that?

Cross:  I mean, I really do think there is a big secret behind owning companies for long time and allowing those companies to deliver for you and compound out their returns. Now, if you got the companies right in the first place, with these strong barriers to competition and strong financial returns, well then, let them do the work for you. And don't keep swapping the fund around.

Petroff: Okay. Now you have three top picks for us today on the small-cap side. We have NCC Group, Iomart Group and UK Mail Group. So, let's go over NCC. Tell me a bit about them and why you like them?

Cross: Well NCC does two things. The first is software escrow. So, they act almost like an insurance company. So, they will hold the blueprint of software independently of the customer and the provider of the software, in case the provider of the software goes down. The other part of their business is very fast growing, and it's all to do with Internet testing. So, testing companies' infrastructure to make sure that it is robust enough.

Petroff: So, they hire hackers essentially to test things out?

Cross: Yes, they have experts, guys with terrific know-how in the world of the Internet, and some companies are facing up to 50,000 attacks a day, and this is a massive issue. And a lot of companies aren't really owning up to it because if you own up to it, then people outside know you have got a problem.

So, they will hire people like NCC to come in and to do investigations and troubleshoot and test to make sure the Internet for that company is really robust.

Petroff: And for the category in terms of intangible assets, does that fit under the intellectual property category?

Cross: They have a lot of know-how. So we get intellectual property through that avenue, but the biggest thing for us is it's a very strong distribution network. They're the biggest in the field in this assurance testing, this Internet testing. Then they're also the biggest in software escrow. So, they have a very big distribution platform through which they can sell their products.

Petroff: Okay. And let's go over Iomart. Now tell me a little bit about them?

Cross: Iomart is a really interesting company. It's a data centre business. And where they were very clever was that they bought their data centers right at the end of the dot-com bust. So, they picked these data centres up very cheaply. They have been deliberately slow in putting people into the data centres because they wanted to get very high added-value types of customers: customers that are growing fast and customers that require extra services, like security and firewalls and back-up fibre and back-up data centres.

So they are filling capacity and that filling of the capacity is leading to very large increases in profitability. Because you have immense operational gearing as we call it, as profits come through on a pretty flat cost base. So, they're doing really well, and we have done well out of Iomart, both in the Smaller Companies Fund and the Special Situations Fund.

Petroff: Your last pick is UK Mail Group. I was a little bit surprised by this. When I think of mail, I think people aren't sending mail as much as they used to. So, tell me why you picked this.

Cross: It's an interesting one because it's an industry that has suffered from too much capacity, but what has been happening in the last year or so, is capacity has been coming out. UK Mail does two things: one is parcels delivery, so that's benefiting a lot from the online increase in people purchasing. The other thing it does is, it has a portion of the UK Mail route. So, up to the last mile, UK Mail can send letters through the Royal Mail distribution system.

And what they're doing is bringing some increasingly new ideas into this and there are things like i-mail, which is all about printing off mail much nearer to the end location of where it is going to. So rather than going say, from Plymouth to Edinburgh, you’d have a print-house in Edinburgh and then it just goes the final leg. So there are efficiencies that are coming, there's innovations coming and overall capacity is coming out of the market, so there is pricing tension, and UK Mail is now seeing earnings upgrades.

Petroff: Now let's go over the key risks for each of these companies. Let's start with NCC Group.

Cross: NCC: it's really reputational risk is the big issue for them. They've got terrific know-how, but if their guys make significant mistakes and things don't work, then there is a reputational issue with NCC.

Petroff: And what about Iomart?

Cross: Iomart has much more to do with the problems of a database going down, a data centre going down. This could be – it might be fire; obviously they have got precautions against that. It could be terrorist attacks, so those – the infrastructure risks are Iomart’s.

Petroff: And for UK Mail, what's the key risk there?

Cross: The key risk there is that capacity, which is coming out now, goes back into reverse. The capacity comes back in again and that destroys the pricing tension that we're starting to enjoy.

Petroff: Okay. Thank you very much for speaking with me today.

Cross: Thank you.

Petroff: That was Anthony Cross from Liontrust, and I am Alanna Petroff. Thank you very much for watching Morningstar.

Find more Fund Managers' Favourites videos here.

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

Securities Mentioned in Article
Security NamePriceChange (%)Morningstar
Iomart Group PLC390.00 GBX1.30-
Liontrust Special Situations R Inc410.00 GBP-0.98
Liontrust UK Growth R Inc433.90 GBP-1.14
Liontrust UK Smaller Companies Inc1,445.06 GBP-0.09
NCC Group PLC212.40 GBX-1.67-
UK Mail Group PLC  -
About Author Alanna Petroff

Alanna Petroff  is a financial journalist with Morningstar UK.