Edmond Jackson's Stockwatch: Liontrust Asset Management

When drawing attention to the FTSE Fledgling shares in this investment manager at 110p last October, I noted how a ninth successive quarter of positive inflows affirmed Liontrust Asset Management's marketing and investment skills. A non-executive director had bought 277,778 shares at 90p and Henderson Global Investors increased its stake to 10%. So if markets could muddle through some macro fears, Liontrust was modestly rated.

Quantitative easing has provided an excellent environment for asset gathering, boosting shares while debauching cash value, and last January Liontrust reported net inflows of £64 million in the third quarter of 2012, over four times the same period in 2011. Then a year-end trading update last March cited assets under management had doubled to £3 billion. I had noted this was also benefiting from the acquisition of Walker Crips Asset Managers in spring 2012, which brought in some £600 million, but £3 billion was still a very good achievement on a key measure.

The shares are currently testing 190p after latest preliminary results to 31 March 2013 showed continuing operational revenue up 49% to £20.5 million and a return to the dividend list with 1.0p a share payable on 26 July, relative to broker notes suggesting the dividend would be resumed only in 2014 with a 2.5p payout.

Judging the trend in profits attributable to owners is somewhat elusive, however. The results' headlines emphasise adjusted pre-tax profit up from £1.0 million to £3.8 million; however, note 4 to the accounts shows this being computed quite generously after costs such as £722,000 share incentivisation and £572,000 "member related" restructuring have been added back. This is fair, in terms of showing how the business is performing without these costs, but they are real. £3.3 million depreciation and intangible asset amortisation was also added back.

Otherwise the income statement shows a 55.7% hike in administrative expenses to £24.1 million increased the operating loss from £1.6 million to £3.7 million; and it appears possible to satisfy HMRC of low/no profits given the tax take has dropped from £250,000 to just £19,000.

Note three clarifies the jump in administrative expenses where, despite director and employee costs falling from £4.5 million to below £1.9 million, "members' drawings charged as an expense" soared from £3.5 million to £10.1 million. There is no explanation in the preliminary results. However, among the various incentive plans cited from page 22 of the 2011/12 annual report, page 24 mentions a "membership incentive scheme" linked to share-price performance.

Putting aside whatever scheme is involved, the problem for outside investors is that with "member drawings" suddenly becoming a multiple even of adjusted profits it becomes hard to judge where this company is heading in terms of profits attributable to owners - the key investment measure. It gives an impression the company wants the benefits of being public while acting like a private partnership.

More positively, Liontrust's investments styles look durable. At end-March, 89% of total assets under management were in three modes: "cash-flow solution" focusing on companies with strong cash flows able to beat low profit expectations; "economic advantage", companies with distinctive characteristics that rivals struggle to reproduce; and macro thematic, a long-established approach in the funds industry of taking "big picture" views. £263 million has been introduced via a new "global credit" theme following January's appointment of a specialist manager and formation of a global credit division.

Find out which of Liontrust's funds was highly commended by Money Observer in:Fund Awards 2013: UK Growth.

Liontrust's progress affirms why I like this kind of business model: once a lean effective operation is established, revenues can expand fast and drop through largely to profits. But as I found with RAB Capital, another investment manager (now delisted), within the company were schemes that siphoned the lion's share of cash to preferred members. No action was taken there by any institutional shareholders to genuinely align owners' interests. Is it because all fund managers like to see a general inflation in rewards, so packages have to keep rising to stay competitive?

Liontrust shares have performed well since last autumn, partly due to favourable markets. The funds have some scope to perform irrespective of general market trends, yet shares in asset management firms remain quite a geared play on markets, not only due to their operating dynamics, but also sentiment affecting flows in and out of funds and reinforcing the shares' trend. So you are implicitly taking a medium-term view on markets at a time when some key risks are emerging.

Company REFS shows that a month ago, Liontrust's broker, Numis Securities upgraded its 2014 normalised pre-tax profit forecast to £7.6 million; similarly N+1 Singer, which combined has the feel of management guidance i.e. internal budget. Another survey of broker opinion shows these brokers targeting 225p to 230p while two others effectively see the shares as fairly priced with 'underweight' stances.

So broadly it depends how markets perform. Liontrust shows itself highly skilled at asset gathering despite varied performance in its retail funds with several in the first and fourth quartile rankings. The chief executive's purchase of 16,078 shares at 166p to own 335,379 shares, last March, showed confidence in Liontrust's momentum, although there have not been further director purchases since the results.

Liontrust is worth watching as potentially a major fund management group taking shape; capitalised at a modest £70 million and growing fast, it should attract high-calibre personnel. This is presumably why the likes of Schroders and Artemis hold 21.4% and 5.92% respectively.

Personally I find the high proportion of "member drawings" makes it hard to forecast genuine earnings attributable to owners, hence investment value. Some company members appear to be more equal than others.

For more information see liontrust.co.uk.