Andrew Merricks, head of investments at Skerritts Consultants, gives his verdict on the Liontrust European Absolute Return Fund.

This fund aims to make money over the medium term in both rising and falling markets by applying the ‘cash flow solution’ process – a process previously tried and tested on the Guernsey-registered Liontrust European Long/Short fund.

Essentially, the fund managers create a list of companies with strong cash flows, which they believe are likely to beat investors’ low profit expectations, as well as companies with weak cash flows likely to disappoint on investors’ high profit expectations. They then select the best long and short positions for the fund.

Liontrust European Absolute Return fund will hold 50 to 80 companies, each with a market capitalisation of at least €1 billion.

Andrew Merricks says:
Absolute Return funds have been all the rage this year as the investment industry has grown to realise that stock markets do not necessarily go up, even over the medium to long term. My own opinion is that we saw a significant shift in 2008 from the more developed economies of the West towards the less indebted ‘emerging’ economies of Asia and Latin America.

If I am right, it is going to become even more important for fund managers to be able to make money from struggling companies as well as from those set to deliver strong results as, arguably, there will be more of the former from which to choose.

You make money from stocks that fall in price by ‘shorting’ them. Traders shorting financial stocks became the pantomime villains during the Lehman’s fallout, but I am strongly of the opinion that you do not short good companies, and these traders were made the scapegoats for the failure of companies that were going to disappoint anyway. To be able to short stocks is actually a very good defensive measure during periods of excessive volatility, so when a manager is good at doing it, I take a close interest in their fund.

Gary West and James Inglis-Jones have been running a European Long/Short fund since December 2006 and have been doing so very successfully, showing a handsome gain throughout the global ups and downs in that time. Importantly, they have done so by following a strict strategy of capitalising on forecasting errors made by company managers. By focusing upon cash flow, West and Inglis-Jones look to take advantage of overly optimistic cash flow forecasts that could pre-empt a fall in the share price should the forecasts fall short of expectations.

Conversely, strong cash flows could lead to the share price rising as companies beat the downbeat profit expectations, which are often prevalent at times when economies emerge from recession.

As long as there are companies, there will be profit and loss. As long as there are investors, there will be profit forecasts. And, as long as there are forecasts, there will be discrepancies. It is these that the Liontrust European Absolute Return fund seeks to seize upon, and for a very fair annual management charge and a low entry point, I’d be confident in predicting a satisfying return for investors.