The "economic advantage" investment process was initially developed by Liontrust to search for businesses with a collection of distinctive characteristics that competitors struggle to match. The British specialist fund management company has seen quite a lot of success so far, as the funds managed based on this thesis have all outperformed their respective benchmarks, including the highly-rated Liontrust UK Growth, Smaller Companies and Micro Cap funds.
The team at Liontrust thinks that all types of economic advantages stem from intangible assets. It regards the following three as being the most difficult advantages for competitors to replicate.
1. Intellectual property
Many of the research-driven businesses are rich in intellectual properties. This group includes multinational pharma like AstraZeneca (LSE:AZN, Financial) and GlaxoSmithKline (LSE:GSK, Financial), both of which are sitting at the top of the holding list at the Liontrust UK Growth Fund.
2. Strong distribution channels
This category of economic advantage is widely seen among consumer brands. For instance, Diageo (LSE:DGE, Financial) and Unilever (LSE:ULVR, Financial), both also top holdings at the Liontrust UK Growth Fund, have built vast distribution networks that would be very difficult and expensive for any competitor to duplicate.
3. Significant recurring business
A high level of recurring revenue enhances predictability, and hence mitigates uncertainty for shareholders. Tatton Asset Management (LSE:TAM, Financial), one of the top holdings at the Liontrust UK Micro Cap Fund, exhibits such a characteristic, as the company derives most of its sales from fund management fees and monthly membership fees.
Other andvantages
While only investing in companies with at least one of the main advantages above, the team also treasures some less powerful but influential intangible strengths, including franchises, customer relationships, brands and company culture.
Furthermore, It is worth mentioning that many superior-quality businesses leverage more than one of the economic advantages to keep competitions at bay and secure abnormally high returns.
One example, according to one of the fund managers, is IMI (LSE:IMI, Financial), a UK-based engineering company that is praised for its in-depth know-how in fluid handling as well as strong distribution channels in more than 50 countries. For the last decade, the business delivered an abnormally high return on capital, although the growth looked a bit modest.
In our opinion, Graco (GGG), a long-time name on our investable universe list, can be a decent example to demonstrate Liontrust's main three sources of economic advantages. The Minnesota-based mid-cap company specializes in the niche of managing corrosive, viscous and hard-to-move materials, with numerous patents in the U.S. and abroad. It partners with more than 30,000 distributors in over 100 markets, creating a giant network of outlets. The high switching cost of the install base and highly-reputed quality of the mission-critical products also allows Graco to harvest predictable recurring revenue, as demanding customers keep coming back for parts and accessories for solutions that they purchased in the first place.
Disclosure: The mention of any security in this article does not constitute an investment recommendation. Investors should always conduct careful analysis themselves or consult with their investment advisors before acting in the stock market. We do not own any security mentioned in the article.
Read more here:
- Software-as-a-Service: A Crowd of Predictable Businesses in an Unpredictable Industry
- Nametschek: Solid Financial Performance and Massive Runway Ahead
- Tatton Asset Management: An Underappreciated Gem in a Fund Management Niche
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