Expert predictions: green shoots or false dawn?
Fans of the TV show You’ve Been Framed will know the ‘what happens next’ game well. We’re shown footage of an elderly lady dancing at a wedding and we get to guess whether she’s about to fall into the cake or launch into a can-can.
A version of this game has been gripping the City for the last few months. Sadly, experts are not debating anything nearly as entertaining; it’s the future of the equity markets that hangs in the balance – and they’re struggling to reach anything like a consensus.
Commentators, economists and fund managers were all united in gloom until a few months ago, when the rally between early March and early May started talk of ‘green shoots’. Experts at Deutsche Bank, JP Morgan and Barclays Capital all announced the beginning of the end of the recession.
They were echoed by the Organisation for Economic Co-operation and Development, billionaire trader George Soros and the International Monetary Fund (IMF). Yet Mervyn King, governor of the Bank of England, also weighed in, pointing out that the gloom remains.
So the bad news is there’s no definitive answer as to what happens next. Fund managers take a stand on what they think the market is going to do and position their portfolio accordingly; whatever funds you hold will be ranged on one side or the other of the debate.
So it’s vital to know what your fund manager thinks – only then can you decide whether you’re backing someone who shares your view. If not, you should consider whether your money is in the right place for you.
To help you get an idea of where your manager stands, we spoke to 10 of the most influential managers holding UK portfolios. We picked funds that are currently the most popular, according to Trustnet, Interactive Investor and Lipper.
Fidelity Special Situations
Sanjeev Shah, manager of the Fidelity Special Situations fund, says: “I’m optimistic about the market; I’m finding more good investment opportunities than I have for a long time.”
He says the price relative to bonds is confidence-inspiring, earnings expectations are more reasonable and business expectations are bottoming.
Shah chooses unloved stocks that are in a position to grow, rather than taking a call on sectors. However, he has his biggest overweight holdings (compared with the UK FTSE 100 benchmark) in the consumer services sector, notably in gaming companies such as PartyGaming. This confidence in companies underpinned by consumer demand is a sign of his optimism, but he still remains underweight in consumer staples.
Shah points out that his confidence is not unbridled. “I wouldn’t go as far as to say that we’re now off to the races,” he says. “I think we’re in the early stages of a market recovery, which will be more gradual. Following the substantial gains of the last month or so, we may see a correction in share prices before markets continue to improve.”
THE CAUTIOUSLY OPTIMISTIC
Cazenove UK Absolute Target Fund
Fund manager Tim Russell believes the rally will be a reasonable one, but it doesn’t mean the beginning of the end – although it is significant enough to encourage him to rebalance his portfolio for the short term.
Russell was a late convert to cautious optimism. Well into 2009 he was going short on things like house-builders and long on defensive stocks like GlaxoSmithKline and British Airways. But he has since accepted that his stance was wrong, and has bought into some cyclical stocks and short-sold one defensive. “I suspect the rally has further to go,” he says, but he adds: “The recovery in 2009 will not be vigorous or sustained.”
Halifax UK Growth Fund
Matthew Merritt, head of strategy for Insight Investment, which oversees the management of the fund, sees some reason for optimism. “Near-term economic news has improved,” he says, “and I expect this trend to continue. It is possible to have a cyclical upswing within a challenging structural backdrop, so I’m less cautious about the prospects for equity markets.”
The fund has backed this view, with a small shift in the portfolio. “At present, we’re focused on companies with strong balance sheets and attractive valuations, with potential catalysts for outperformance. We’ve recently added exposure to those stocks most likely to benefit during an ongoing equity market recovery,” he observes.
However, Merritt also says there are powerful negative factors to consider. “The healing process will be measured in years,” he warns. “Bank balance sheets are likely to continue to contract and growth is expected to be below trend as consumers try to rebuild their savings. The current market rally has come a long way, so it’s vulnerable to pull-backs.”
THE DECIDEDLY NEGATIVE
Invesco Perpetual, Income and High Income
Neil Woodford, manager of both of these funds, says he isn’t “especially optimistic” about the future. “This crisis will be running for a long time. It’s not like any recession in recent history, and my view is that it will go on a lot longer than the second half of this year.”
Instead, he is expecting a long, slow adjustment, as debts in Western economies are slowly paid and emerging economies gradually begin to dominate the market. “We could be in a weak economic environment for a long time yet – three to four years at least,” he says.
Woodford has been investing in cheap businesses he believes can “get through this very tough economic environment in good shape, ones that will grow cash flows and dividends”.
He identifies these by looking at the activities of the firm and where it generates returns. He then makes a judgment about “how resilient that business and its cash flows will be, and how well it is managed”.
He has found businesses in this position in the utility, tobacco and pharmaceutical sectors, all of which tend to outperform in tough times.
Newton Higher Income
Tineke Frikkee, manager of Newton Higher Income fund, continues to be cautious. As an investment house, Newton follows ‘thematic’ investing, which works on the basis that certain themes dominate the market and need to be factored into stockpicking. One such theme is ‘All Change’, which means the debt hangover will rein in growth for a long time to come.
Frikkee says: “From a decade-long acceptance of cheap borrowing, we’ll move to a more prudent environment, with more sensible borrowing. From a company point of view, I expect a lot of de-leveraging, while from a consumer point of view, household debt levels still remain too high. We haven’t seen them come down yet, and this is an essential part of the process. This has huge implications for consumption; de-leveraging typically takes years.”
The Newton fund is in “companies that can get through this with low debt levels and strong balance sheets”, says Frikee. “It favours the FTSE 100, with a decent amount of overseas earnings.”
As an income fund, it also focuses on firms it believes can grow dividends.
Frikkee adds that even once the economy has reached a stable base, future growth is going to be nothing like as rapid as in previous years.
Newton UK Opportunities
Fund manager Ben Russon’s approach also reflects Newton’s ‘All Change’ theme – many of his investments are in defensive sectors. “I have very little in financials, areas that are exposed to consumer demand or anything that’s broadly cyclical,” he explains.
In addition to these broad sector calls, Russon says: “We have a team of research analysts looking for stock-specific opportunities, and I’m happy to include recovery stories within the portfolio.”
However, he isn’t looking for stocks that will rise in a recovery. “I like companies where there’s an element of their destiny being in their own hands,” he says. “For example, Cadbury has a clearly defined margin-improvement plan, and if the management can execute it effectively, that will be the main driver of returns rather than the wider economy.”
Jupiter Income Trust
Fund manager Anthony Nutt believes there are still tough times to come. “Although we have probably seen the low in UK indices, there’s nothing to suggest that this has been anything other than a sharp rally in a secular bear market – one that is likely to be prolonged in the wake of both a financial crisis and a global recession,” he says.
Nutt points out that the slight recovery is “only from some awful lows”. He highlights the results of an IMF study of 122 recessions over the past 50 years in 21 countries, which found that those associated with financial crises tend to be severe, long-lasting and end with a weak recovery.
“On average, highly synchronised recessions associated with financial crises lasted for just over seven quarters. If the UK entered recession around May 2008, then a recovery might not begin until the end of Q1 2010,” he warns.
As a result, Nutt has positioned his investments defensively. “We retain a portfolio of defensive growth stocks,” he explains. “Diversified global businesses such as gas, oil, telecoms, pharmaceuticals, insurance underwriters, transport and beverages seem well placed to support dividends, with their strong cash flows and low levels of debt.”
Then there are those who select each stock on its merits. It’s much harder to know what’s going on in these fund managers’ brains, but you can get a snapshot of their portfolios.
Fund manager Tom Dobell has overweight positions in a variety of sectors and specialists, from Tullow Oil (oil exploration), Quantum Minerals (commodities) and Invensys (engineering) to Unilever (consumer goods). Some of these stocks would gain from a growing world economy with a boom in demand for commodities, but Dobell’s not relying on a recovery for these companies to perform.
Meanwhile, he has taken a stance against firms such as BG, AstraZeneca, British American Tobacco and Tesco. Some of these are considered defensive stocks, while Tesco relies on the consumer. However, he has rejected them on grounds specific to each company. As a result, he claims his portfolio “should perform in any market”.
Adrian Frost and Adrian Gosden equally don’t take a position on the overall market.
But they have responded to optimism in the market, buying some recovery stocks such as BHP Billiton, property and capital goods companies.
However, they warn: “Some participants are throwing money at recovery in a fairly indiscriminate manner; we’re not chasing this trend.” They are also picking winners from defensive sectors, with overweight positions in Centrica, Shell, Unilever and energy company RWE.
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