Liontrust Global Smaller Companies Fund

Key highlights

• Pockets of excess drove market returns in Q3, as low-quality rally continues.
• The Fund’s focus on high-quality businesses led it to lag.
• Many of the AI beneficiaries on this year’s small cap rally are unprofitable and unproven, and therefore uninvestable under our long-term quality compounding framework.

Performance

The Liontrust Global Smaller Companies Fund returned -0.3% in Q3, compared with the 10% return of the MSCI ACWI Small Cap Index and an average return of 7.3% in the IA Global sector, its comparator benchmarks.

Commentary

Equity markets saw strong performance in Q3, with the US stock market hitting record highs, supported by resilient corporate earnings and easing tariff uncertainties. The US Federal Reserve cut its Fed Funds interest rate by 0.25% in September, driving a further rally particularly in rate-sensitive sectors. US small caps outperformed US large caps. 

In Europe, small cap performance lagged the US, impacted by political uncertainties in France, mixed macro data, and the German equity rally running out of some steam. In Japan, small caps continued to rally despite political volatility, as corporate reform continues to deliver improved shareholder outcomes.

Emerging market small caps saw healthy gains, particularly in China where the market is beginning to regain enthusiasm in the context of supportive policy stimulus, low valuations, and a trade truce with the US. Taiwanese small caps also continued their run of strong performance year to date as the extensive semiconductor supply chain there benefits from the global AI capacity build out.

The Fund underperformed in Q3. In our view, the market has been characterised by high levels of retail investor speculation, a low-quality rally since the tariff volatility earlier in the year, and significant ebullience around the duration of an AI build out. As a result, we have seen some pockets of excess that have helped drive market returns over the quarter. As one may expect from the Economic Advantage process, our focus on investing in high quality businesses, with valuation discipline and a long term perspective, has meant our style has lagged significantly in this market environment.

For example, strong retail investor participation in rather speculative stocks has led to Goldman Sachs’ ‘memes’ basket of stocks (up +73% YTD*) now once again outperforming the S&P 500 since the basket’s inception*:

*Source: Bloomberg, data from 1 Feb 2020 to 7 Oct 2025.

Since the ‘Liberation Day’ lows in April, we have seen the lowest quality stocks lead the recovery. In Q3, the low-quality rally continued alongside exceptional returns for anything linked to AI, data centres and the localised energy infrastructure needed to power them. The MSCI ACWI Small Cap Index includes just under 6000 stocks. The top 100 performers in Q3 delivered a +131% return on average (in GBP), yet the average ROE (return on equity) for that subset is -10.6% and 61 of those 100 companies are free cash flow negative. The table below highlights the headwind to quality-conscious investors in the current market; the best performing quintile of stocks in the MSCI ACWI Small Cap Index also had the lowest average ROE, whilst the worst performing quintile of stocks had the highest average ROE.

Source: MSCI, Bloomberg, Liontrust calculations, total returns.

The Economic Advantage process consists of four key pillars that enable us to identify and own the highest quality companies capable of long-term compounding: (1) a focus on unique intangible assets difficult to replicate for any competitor, leading to (2) high cash flow return on invested capital – greater than of the cost of capital and enabling excess profits to be reinvested at consistently high returns, (3) valuation discipline at both entry point and throughout equity ownership, and (4) alignment of incentives by only investing in small caps where management own 3% or more of the stock. 

This has led us to invest in businesses that have demonstrated track records of winning in their fields and allocating capital sensibly over time, operate in secular growth industries, and are in our view undervalued for their long term compounding potential. 

Our disciplined process has led us to invest in some companies that are indirectly benefitting from the AI capacity build out. Chroma ATE in Taiwan is the market leader in system-level testing machines for AI semiconductor chips. Inficon in Switzerland is the global leader in leakage detection systems for cleanrooms (extremely clean and controlled areas where semiconductors are made). Tri-Chemical Labs in Japan is a chemicals supplier to memory and logic chip makers with a focus on niche categories it can dominate. However, many of the AI beneficiaries driving global small cap returns this year are unprofitable with unproven track records, and therefore un-investable within our long-term quality compounding framework.

Quality as a style has therefore underperformed in the current market environment. We think the chart below from Jeff Weniger (Head of Equity Strategy at WisdomTree) highlights the current paradigm effectively. (The S&P 500 Quality Index is calculated based on ROE, accruals ratio and financial leverage ratio).

Top contributors:

• Medpace Holdings (+67% total return in sterling terms) – Despite continued funding difficulties for many small biotech firms, Medpace delivered a very strong set of results and order book, given its niche focus on helping biotech customers take new drugs through trial phases. This indicates it has continued to gain market share. We visited Medpace’s management team and major ImmunoDx lab at their HQ in Cincinnati in August. The long-term oriented culture and partnership-driven sales approach made us confident in Medpace’s growth runway for many years to come. Medpace also bought back c.5% of their share count in the quarter at low prices – demonstrating exceptional capital allocation.
• Installed Building Products (+39%) – Shares rose as signs of stabilisation emerged in the US housing cycle. Q2 earnings showed insulation installation volumes holding firm despite still-challenging mortgage affordability. We recently wrote about our visit to IBP HQ in Ohio and reasons for ownership.
• Advanced Drainage Systems (+23%) - ADS reported strong quarterly results well ahead of expectations, as despite challenging conditions in construction end markets, the business proved its quality credentials via ongoing efficiency gains, pricing stability, and innovation in higher-margin product lines supporting demand. 

Largest detractors:

• Interparfums (-23%) - Reported second-quarter results that highlighted short-term challenges to consumer spending. However, full-year guidance was reiterated. The company continues to invest in and expand its portfolio of fragrance brands, as evidenced by recent agreements with Longchamp and Off-white. The founders, who collectively hold over 40% of the company's equity and have more than forty years of expertise in the fragrance sector, not only view temporary setbacks as opportunities but also lead the management team with confidence and experience, guiding the company through challenging periods.
• Progess Software (-28%) - Despite quarterly results that beat sales and earnings expectations, organic growth was underwhelming. In late July, it was announced that a class action lawsuit against Progress and other defendants relating to the large 2023 Moveit data breach proceeded to trial on a number of counts. We exited the position in August.
• Sysmex (-27%) - Sysmex is the world’s leading blood-testing machine maker, with incredible IP and leading expertise in haematology, haemostasis and also urology. It has more than 50% global market share in haematology analysers. More than 60% of its sales come from reagents, which are the one-time-use components required to run blood tests on its machines, and therefore are largely recurring items, and support a very stable revenue base. Sales growth is driven by global blood testing volumes, market adoption particularly in fast growing regions such as India and LatAm, and innovation (we are particularly excited about the new XR series of haematology analysers Sysmex has just released). However, Sysmex’s China sales (around a quarter of total revenue) were hit by a change to set testing procedures and government procurement policies aimed at controlling medical costs given the country’s aging population and higher healthcare needs. Over the long term, Sysmex’s business in China will grow given these higher healthcare needs, but policy changes will certainly create volatility.