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Fall&#39s gold

At last year&#39s PIMS conference on board the Oriana, I asked IFAs whether equity income funds were fishing in stagnant waters. The answer then was a resounding no – and is still a resounding no today.

Stockmarkets have moved sideways for the best part of 18 months. Two years ago, people were looking for something different – something that gave good returns on investment during a time of deflation. They found a new fix with technology, media and telecoms stocks but then the sector tumbled.

Such a speculative flurry and subsequent fall has been seen before and I am sure it will happen again. But each time there is a fallout in the stockmarkets, opportunities will arise because there will always be some fundamentally good companies remaining in the aftermath.

Equity income managers have been among those to pick up the pieces and grab the opportunities. We are looking for the deeply undervalued areas of the market that have been overlooked – stocks which have not got carried away in a strong wind of TMT euphoria.

The result has been something of a renaissance in the equity income sector.

The value of the average UK equity income fund may have fallen by 2.9 per cent in 2000 but this was somewhat better than the average UK all companies fund, which fell by 8.3 per cent, or the FTSE All Share, down by 5.5 per cent.

The surge in tech stocks seen last year will not be seen again. The vast majority of tech companies will go into mediocrity or liquidation.

I do not think technology is going to go away, however. It is really a case of the old economy embracing the new economy. Those established areas of the market that embrace technological developments will be the winners.

This makes sense because they have the customer franchise,intellectual property and brand names which are always important.

Today&#39s income funds are not the same as a decade or so ago. In the 1970s and 1980s,yields of 5 and 6 per cent were not uncommon. I cannot see those days returning for a long time to come – if ever.

Today&#39s economic environment of low inflation and low interest rates has seen yields fall to about 2 to 3 per cent. Equity income funds only have to yield 125 per cent above the FTSE All Share average of 2.2 per cent.

It has meant we have had to adapt to counteract the low-yield problem. If I am going to grow my dividend distribution, I cannot do it by dividend yield alone. I have got to get capital growth.

The only way to manage equity income funds today is to complement a modest yield with decent capital appreciation. Investing for the sake of a yield is no longer necessary.

But when all is said and done, investing comes down to cost of cash.

Investors will only continue to invest in companies if they can deliver sustainable rates of growth at a fair price. The moment those ratings become unsustainable is the moment people stop funding those businesses. As a manager, you have to be comfortable with your valuation.

Going forward, the overriding restraining issue is the US economy. Much of it will come down to investor confidence. US citizens have a much greater part of their net wealth in the stockmarket than the British who seem more worried about property prices. If the US economy continues to slow, confidence may slide.

But if there is a hard landing in the US, perhaps we should not be too surprised. The market falls in November could well mean the worst is behind us. But whatever happens across the Atlantic, I feel good about the UK market. It has a consistent performance on all fronts – on inflation and growth – to pull it through.

There are some cracking opportunities out there to pick up stocks that offer good long-term value. Yes, there are companies that have made significant downgrades but many of those are in sectors that have been outperforming.

My biggest weighting at the moment is in the financial sector. I also see opportunities in cyclical companies and some of the breweries such as Scottish & Newcastle.

The banks are still undergoing consolidation and benefiting from targeting their customer base more competently. The financial sector is also a defensive play. It will remain defensive as long as we do not get an economic downturn from here. But should we get more bearish, issues associated with bad debt may arise and my stance will change.

Generally, however, I feel more bullish than bearish. I think equity income funds will continue to do well. What has gone away is investors&#39 appetite for high risk. Anyone who flirts with it at this point in time is doing so at their peril.

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