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Dodging torpedoes

Investment flows are undoubtedly polarised at the moment. Some investors are seeking high potential returns through emerging markets, specialist funds and singlecountry funds such as India and Russia. Others are seeking the safe haven of cash or more recently bonds. The latter, as I have mentioned before, look good value.

Hardly anybody is talking about the middle ground. By this, I mean good quality equity funds in core markets such as the UK, US and Europe.

I can understand the caution to some degree. After all, these economies do not exactly look healthy at present but to ignore these markets would be a mistake.

First, stockmarkets can perform well even during periods of slow economic growth and, second, there are many high quality fund managers investing in these areas.

One middle-ground fund that has caught my eye recently is JO Hambro UK opportunities.

Fund manager John Wood identifies that the main risk to a share portfolio is holding the bad shares, in other words, the ones that can completely torpedo you, rather than missing out on the good shares.

There has been much angst over bank shares and whether now is the right time to buy. To me, this seems like a hero trade at present. Why take the risk? Why not look at other opportunities?

Wood believes that the economic cycle is at a similar stage to where it was in 1991 and therefore he expects to see a big drop in consumption, particularly among the 25 to 35-year-olds who are the real spenders. This would obviously have a negative impact on retailers that thrive on discretionary spending.

The last severe market downturn was in 2000/01 when the technology bubble burst. However, that was very much a sector-specific affair and did not have a direct effect on the UK consumer.

Banking problems are very different and tend to have a wide impact on the economy.

Wood looks to identify long-term trends and themes involving high quality but undervalued companies. It is not a static portfolio and he is active in the market, looking carefully for companies that are likely to be insulated from economic problems.

He notes that the stockmarket indices are getting very distorted, with yet more mining companies about to join the FTSE 100, pushing the mining sector to about 16 per cent of the index.

Fans of index trackers beware – they are not as diversified as you might think.

In a market like this, stocks that release disappointing trading updates will get hit badly, so Wood is prepared to sell quickly. He has already done this with Smiths Group and has also been a seller of ICAP, which he believes will suffer as new regulations begin to curtail its innovative business model. The portfolio is highly focused and typically contains just 30 stocks. It is currently biased towards bigger companies.

Wood is seeking to invest in companies which have good diversification in themselves, in other words, their fortunes are not linked to the success of failure of a single product.

An example is Legal & General, which is involved in a variety of activities and has an especially profitable annuity business. Someone in the UK turns 60 every 30 minutes, so it is not hard to see how this business is going to grow.

Other well known names in the portfolio include Prudential, Tesco, National Grid and Centrica. The stocks in the portfolio are given roughly equal weightings and the overall trend is for them to have low or zero debt and strong balance sheets.

The primary characteristic of the bull market of 2003-06 was that highly leveraged companies rose strongly. The aim of the game has changed dramatically. Companies which are solid, safe and have little or no gearing are more likely to make money. JO Hambro UK opportunities looks to exploit this trend while it lasts.

Mark Dampier is head of research at Hargreaves Lansdown


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