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The case for UK Equity
By Fiona Hamilton
Share prices have recovered well from their early-March malaise, but remain vulnerable to doubts about the US economy. US consumers account for over 60% of the US economy - which accounts for 30% of the world economy - so if weak US house prices continue to undermine US household spending, other parts of the world could eventually suffer.
On this basis, it may be sensible to consider funds
which should be relatively resilient in the event of any future upsets. A lot of investors have been pinning their faith on property-related vehicles, but institutions have been turning to UK Equity Income, and it is not hard to see why.
UK Equity Income funds tend to invest mainly in large companies, which look much less demandingly valued than the medium-sized companies which have done so well in recent years. UK Equity Income funds generally concentrate on shares which pay out a good dividend, and those dividends should help support the share price when there is a market setback. Yet another attraction is that the UK Equity Income sector boasts a number of top class managers, who have proven their ability to cope with difficult conditions.
Invesco Perpetual
Neil Woodford could be dubbed the UK Equity Income King. Based in Henley-on-Thames, well away from the hubbub of the City of London, he has managed Invesco Perpetual High Income fund since 1988 and the closely related Invesco Perpetual Income fund since 1990. Both have had dull patches, notably in the late 1990s. But Woodford's reluctance to join the rush into technology, media and telecommunications companies at the height of the dotcom euphoria was fully vindicated in the subsequent bear market, and the funds' short and long-term success has been such that they have attracted of over £12 billion of investor's money.
Woodford attributes his ascendancy to the fact that he runs a 'cautious first' portfolio. He concentrates on investing in undervalued assets, which tend to perform well (over time) because they are undervalued. He accepts this sound simplistic, but there is no quibbling with his performance. His large holdings in tobacco companies such as British American Tobacco (BATS) and Reynolds American (RAI) might deter the anti-smoking brigade. But utility holdings such as Centrica (CNA) and National Grid (NG-) are less contentious, and his 2006 winners ranged from British Airways (BAY) to Homeserve (HSV) and Tate & Lyle (TATE).
Recently, he has been focusing on defensively positioned companies with strong cash flows. He remains ready to pounce on shares which have been unduly knocked back, such as Sage (SGE), and is confident there are other bargains to be found.
"Despite my concerns about the rising risks and the more difficult economic and market environment, I still believe we can make money in this environment."
Investing in financials
One area Woodford is avoiding is banks. He has had substantial exposure in the past, but is currently reticent, despite their modest share prices and good yields.
"Credit quality is deteriorating, and I believe that revenue growth will slow and cost growth will remain relatively stubborn," he says.
His doubts are not shared by two other high flying equity income managers, George Luckraft of AXA Framlington Equity Income and Karen Robertson of Standard Life UK Equity High Income (STUHIA). The former has around 24% in financials and the latter around 30%. Both have large stakes in Royal Bank of Scotland (RBS) and Barclays (BARC), but Robertson has done well to side step HSBC (HSBA), which has had a rough ride recently.
Standard Life
The Standard Life UK Equity High Income fund has been top quartile over most periods since Robertson took over in 1996 and it has the lowest charges and the best yield of the funds mentioned in this article. Robertson looks for improving situations which have not yet been recognised by the stock market, and is greatly helped by a screening process developed within Standard Life. She works closely with her UK equity colleagues, several of whom are also doing well within their sectors.
Standard Life remains very positive about UK Equities, on the basis that companies are keeping costs under control and takeover activity remains rampant. Robertson says UK share prices do not look expensive and she is not unduly worried about inflation or credit pressures.
George Luckraft is more cautious, and has been for some time, which helps explain why his fund has been uncharacteristically dull over the last year. Significant holdings in medium-sized companies contributed to his earlier success, but he now believes there is more value in mega-cap companies - such as BP (BP-) and GlaxoSmithKline (GSK) - or at the bottom end of the market.
James Henderson shares his belief that the best value is now at the top or bottom of the market. Henderson is one of Henderson Global Investors' star managers and his Henderson UK Equity Income (HEHI) fund has perked up a lot since he took charge in January 2005. He shares Neil Woodford's cautious outlook and obsession with value, but enjoys much greater flexibility because his fund is so much smaller.
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