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From Special Report: Global Opportunities - May 2012

Chances still abound to bag UK plays

In spite of troubles, equities could still hold promise

By Jenny Lowe | Published May 28, 2012 | comments

The Bank of England has held interest rates at record lows of 0.5 per cent for more than three years. In such a sluggish environment, yields and valuations on many UK assets have remained at historically depressed levels.

In spite of the short-term swings in financial markets, a range of investors maintain this represents a long-term opportunity to buy into a number of key UK asset classes.

According to Andrew Cole, manager of the Baring Multi-Asset fund, 2012 is looking more positive for equities, in spite of there being a number of potential strong headwinds. In March, his allocation to equities included more than 20 per cent in the UK.

He says: “In the long term, equities will perform well but one bad year can wipe out several good years of returns. By making significant changes to our asset allocation we seek to hold the right asset at the right time to produce good returns but also preserve capital in falling markets.”

James Millard, chief investment officer at Skandia Investment Group, echoes this view, suggesting that equities will go higher in 2012 in spite of already posting record performance in the first quarter. On a global basis, equities had their strongest quarter in more than 10 years on the back of strong economic data and hopes that the European debt crisis was past its worst point.

Within UK equities, Derek Mitchell, manager of the Royal London UK Mid Cap Growth and UK Opportunities funds, is seeing opportunities in a broad range of sectors. While Mr Mitchell remains defensively positioned with weightings biased towards consumer staples, telecoms and pharmaceuticals, he also favours certain industrial stocks that are well placed to take advantage of the current economic environment, as well as companies whose earnings are derived from important overseas markets.

Like his colleague Martin Cholwill, who runs the Royal London UK Equity Income fund, Mr Mitchell also recognises the contribution UK stocks can still make to their long-term returns by raising the income they offer in the form of dividends.

Where income is concerned, however, investors are overwhelmingly favouring a single asset class: bonds. According to the IMA, fixed income was the leading asset class for the seventh consecutive month with net retail sales of £660m in March. The average monthly sales of fixed income funds in the past 12 months was £465m. The first quarter of 2012 was the best for fixed income funds since the third quarter of 2010. In terms of returns, investors enjoyed a return of 13.5 per cent from UK bonds last year, the largest annual return from this asset class since 1998.

It is important to acknowledge the market has experienced some unusual conditions in the past three years which may not be repeated. The Bank of England in particular has bought up a third of the gilt market under its quantitative easing programme, which it started just after interest rates hit their record lows.

Nevertheless, in spite of the overwhelming skew towards gilts, Jonathan Platt, Royal London Asset Management’s head of fixed interest, says active investment managers still have real scope to deliver enhanced performance for fixed income investors. He prefers corporate over government debt, overweight positions in global and inflation-linked bonds, a bias towards secured debt or instruments with strict contractual terms and low exposure to the risk of monetary policy tightening – in other words, a hedge against the end of extraordinary monetary policy programmes such as record low interest rates or quantitative easing. Mr Platt also points out that sterling fixed income benchmarks as a whole also offer UK investors a reasonably international reach.

For all the talk of international exposure, a clutch of investors are still seeing value in investments exposed to the UK. One example is property, where the ongoing uncertainty in the UK economy has led to many investors lacking the confidence to invest in anything but the best commercial premises in London and the south-east. However, Phil Clark, head of property investment at Kames Capital, argues that there are still plenty of opportunities in the rest of the UK market.

Mr Clark suggests that, given the severity of falls in UK commercial property values in 2008-09, investors should not lose sight of the 8.1 per cent return from UK commercial property market last year, or that the volume of commercial property transactions in 2011 were in line with the historic annual average of £30bn.

He adds: “However, the problems arising out of the exuberance of the last economic cycle are now giving rise to the opportunities in the next, as banks continue to deleverage their exposure to UK commercial property and more experienced investors look to buy commercial property investments outside of London and the south-east.”

And as doom-laden times often throw up the cheapest and most attractive bargains, the UK’s latest recession may present investors with more domestic opportunities than they think amid the country’s ongoing economic woes.

Jenny Lowe is features editor at Investment Adviser

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