The Daily Interview: piling into pharma

Liontrust's Citywire AA-rated Anthony Cross (pictured) and Julian Fosh have doubled their exposure to large cap pharmaceuticals since July as the sector's defensive qualities have come to the fore in turbulent markets.

The pair, who co-manage the Liontrust First Opportunities  and Liontrust Intellectual Capital funds, have doubled respective weightings in GlaxoSmithKline and AstraZeneca and have seen their risk-averse investment strategy help to drive Intellectual Capital to the top of the UK Smaller Companies and First Opportunities into the top quartile of the UK All Companies sector over the year to 31 October.

The duo believe that during bull markets investors tend to overlook the pharmaceuticals sector for having duller returns than other areas and ignore how much the two firms are spending on research and development which makes them a more attractive long term investment bet.

Julian Fosh says: 'People are rediscovering that these companies throw a lot of money at discovering new drugs, which tends to lead to good long term returns on capital.'

He said much of the two firm's de-ratings over the last few years had come from analyst concerns over patents and worries over the strength of drug pipelines.

Fosh added: 'People have been too focused on the specifics of the drugs pipeline but in recessionary times people remember the market can go down 10% in a day and these stocks look comparatively better.'

The managers have also refined their two-tier investment criteria which views the intangible assets of companies as important in stock selection.

To pass the tier one level, a company must have at least 75% of its revenue from repeat business, have a strong distribution model which others find hard to replicate, or have strong intellectual property ownership. 

The remaining tier two criteria include a firm's culture, brand advantage, financials, and strong customer relationships and databases.

Cross and Fosh have also benefited from avoiding consumer stocks and focusing on the best of breed winners across sectors including manufacturing and service support.

In the manufacturing sector, the pair have long term core holdings in power supplier Aggrekko, Rotork, Renishaw and Spirax-Sarco which all constitute at least 2.5% of respective fund holdings.

Cross said: 'In a global downturn, the whole sector is under pressure but these stocks are well financed with world class management, and will emerge stronger as others fall by the wayside.'

'We are focused on world class engineering midcaps which have strong distribution, decent reoccurring revenues and strong intellectual capital.

Other strong performers have included software firms Vebnet within the First Opportunities fund, and Focus Solutions.

Vebnet was recently acquired by Standard Life for double its share price.

All firms in the small cap focused  Intellectual Capital funds must be at least 3% owned by the management and have net cash on the balance sheet and Cross and Fosh also have longer than average holding times for both funds.

Cross adds: 'The joy of finding businesses we believe in is that you have no end date in mind.'

'Risk analysis has  become massively important along with the need for sensible balance sheet structures. Because of these structures in place, we have avoided most consumer facing stocks including all retail banks and housebuilders.'

Over the year to 31 October, Liontrust Intellectual Capital has returned -32.46% against the Hoare Govett small cap (-investment trusts)benchmark's -47.12%.

Liontrust First Opportunities has posted a loss of 32.97% against the FTSE All Share return of -38.24% over the same period according to Lipper.