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Liontrust unveils European absolute return fund

Liontrust’s European absolute return fund is designed to produce positive returns in all market conditions by investing long in equities and using derivatives to create short positions.

Short selling is where fund managers make a profit by borrowing shares, selling them and buying them back when the price has fallen. Ucits III does not allow fund managers to short securities directly, but Liontrust will use derivatives to create the same effect.

The fund is managed by Gary West and James Inglis-Jones, who have have managed European absolute return funds since 2004, including a European long-short hedge fund at Liontrust since 2006. They have worked together at Liontrust, Polar Capital and JPMorgan Fleming for 10 years.

The new fund will use Liontrust’s cashflow solution investment process. This starts from the basis that profit forecasts which are used to value future profits, can be unreliable. This provides investment opportunities through an analysis of cash flow.

Strong company cash flow is seen as a good indicator of strong growth in future profits, while weak cash flow can predict a collapse
in reported profits. West and Inglis-Jones will buy companies generating strong cash flows that are likely to exceed low profit expectations and sell short firms with weak cash flows that look unlikely to meet their high profit expectations.

Two measures are used to assess cash flow. The first defines good cash companies as those who spend cautiously, generate high returns on invested cash and are likely to beat profit expectations. Bad cash companies do the opposite.

The second measure ranks companies according to how the market values a company’s cash flow. A high relative cash flow indicates a cautious forecast that can be beaten, while a low relative cash flow suggests aoveroptimistic forecast that are hard to achieve.

The managers use the cash flow measures to highlight the best and worst 20 per cent of a universe of around 6,000 stocks. This produces a short-list from which the final portfolio is constructed.

Synthetic shorting allows the manager to benefit from companies performing badly rather than trying to avoid them, as long-only portfolio managers do. It introduces an element of risk that has nothing to do with markets and everything to do with the manager’s skill, so long and short experience is invaluable.

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