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Build on rewards of under-rated stocks

Between March and July, income funds with little exposure to telecoms, technology and media and large exposure to old world value stocks performed particularly well.

However, that period of dramatic outperformance is now over and, although the market is at the top end of its recent trading range, there is very little market leadership.

We believe the market is reasonably attractive but there will be no strong major investment themes.

Successful funds will be those where value is added at the stock-specific level and individual stock selection is going to be the key to out-performance.

Opportunities will present themselves in all areas of the market – growth and value – but it is still our view that the best opportunities are likely to rest in old world intrinsically undervalued stocks.

The recent corporate action from venture capitalists has reinforced investors&#39 awareness of this undervaluation. One mini theme that we are particularly attracted to at the moment is building and contracting companies.

Here, many companies are selling on five-year relative lows and, with interest rates now much less volatile and the economic cycle becoming less pronounced, the quality of the earnings is improving dramatically.

In addition, both in the US and the UK, governments are running big budget surpluses and have announced spending programmes which should underpin the profits of many building-related companies for the foreseeable future.

In the UK, it is possible to buy good-quality building companies on big discount ratings to the market and at significant yield premiums.

Other areas of the market where we are overweight are engineering, where a number of quality companies are selling on depressed ratings because of the strength of sterling, and food manufacturers, where predictability of earnings and yields available are not fully appreciated by the market.

There are signs that the UK economy is beginning to slow to a more sustainable rate of growth and we believe we are quite close to the interest rate peak of this cycle.

That should enable equities to continue with their gentle upward progression towards the end of the year.

Although the market looks quite expensive on historic parameters, there remain a number of interesting investment opportunities across the breadth of the market to keep fund managers busy and optimistic.

The only two potential short-term negatives influencing the market that I can foresee are a continued disruption to currency markets from the weakness of the euro or a corporate “accident” occurring in a major technology or telecoms-related company, given that expectations here are still very high.

On balance, we think the market is attractive and there remain enough interesting opportunities in income-related stocks for this asset class to be rewarding for investors.

Current markets allow the value fund manager to flourish. Moreover, stockpicking in this environment is absolutely key. This is not the time for lazy fund managers.


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