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Is India all the Raj?

Our panel weigh up if growth is returning to take over from over value and consider whether India is the new China

Are we seeing a return to growth over value?

Hollands: Yes, after a five-year period, where value has significantly outperformed growth, there are now signs that the story has started to move on.

In recent years, companies that have returned capital to shareholders via dividends and share buybacks have been rewarded by the market, hence the strong performance of equity income funds. In fact, the level of free cashflow generated by UK companies is now at a 20-year high. In contrast, Capex – the level of money that companies use to upgrade physical assets – is at a 20-year low.

A reversal in fortunes seems long overdue. This does appear to be happening now as the market’s appetite for risk has improved.

Since the beginning of the year, companies that are increasing gearing are outperforming stocks that are deleveraging and those companies which do have strong Capex growth are outperforming those with weaker Capex growth.

Market sentiment has shifted towards backing growth companies. There has been a pick-up in corporate activity and markets have been acting favourably towards acquisitive firms. This is a significant change, given that in recent years many investors adopted the notion that mergers and acquisitions are value-destroying as a “universal truth”.

Potter: I have never been a fan of style investing, believing that while factors that define value and growth can be helpful with portfolio construction and risk management, they are just that and, ultimately, no manager should limit the choice of investment.

Value or growth companies can equally prove to be good investments if you get your timing right and the unbiased investment manager is certainly better placed to capitalise. Having said that, companies with value characteristics have done better in recent years and growth looks set for a better relative performance in the months ahead.

Remember though, there are only a handful of genuinely long-term growth companies, so a value discipline is still relevant.

McDermott: There are a number of fundamentals that are pointing to a return of growth over value. Anecdotal evidence from our manager meetings seems to suggest growth stocks are coming back into favour.

What is the outlook for the US market?

Hollands: I believe that US equities will continue to generate positive returns but there are better opportunities elsewhere. The US has enjoyed a prolonged period of earnings’ growth but the economy is now decelerating and interest rates have been rising. US equities are not compelling in valuation terms against many other markets.

The big question mark is over what US corporates will do with the enormous piles of cash they are currently generating. There seems to be little appetite for M&A.

Potter: Undoubtedly, the valuation of the US market is better now than it has been for some time. The economy is reasonably strong, corporate earnings are healthy, with recent results generally better than predicted and corporate cashflows are at high levels, not to mention the likelihood of more merger and acquisition activity.

A reasonable second half of the year is possible but there are obvious imbalances in the economy which need to adjust over time. A gradual improvement in share values over the next year or so seems the most likely outcome.

McDermott: The outlook for the US market is unclear. It has been a good market for sterling investors due to the strong dollar. Company results and forecasts look good but the rising oil price and rising interest rates are hitting sentiment and we would have a neutral view in the short term.

Is India the new China?

Hollands: India is certainly being billed by some as the new China but this is a somewhat simplistic view. For example, India will not have the same near-term impact on global demand and supply dynamics in the commodity or manufacturing areas that China clearly has had.

However, the long-term growth outlook for India appears attractive, even relative to China. India has much better demographic trends. Over the coming decades, India will supersede China as the world’s most populous nation. India is being taken much more seriously as a destination for foreign investment now, yet there is still a long way to go. Foreign direct investment into India was only $5bn last year compared with $50bn for China.

Potter: Of course, there are parallels to be drawn between the two. Infra- structure spending has been strong in China and India is set to embark on a similar path. In a number of respects, however, you could turn the question on its head.

India is already the biggest democracy in the world and company accounting standards are at a level that many Chinese corpor- ations should aspire to. Both are similar but also different.

It is safest to say that both offer exciting long-term investment potential, with a combined population over one-third of the world’s total, but volatility will also be a feature of the investment journey.

McDermott: India and China have a lot of similarities. Both are rapidly developing countries with big populations and hence a large workforce. China specialises in manufacturing while India is more specialist in IT and call centres.

What they do share is an increasing wealth in the country and a growing middle class which will lead to increasing consumer spending and a growing economy.

The big difference is that the Indian market has been rising through this period of growth whereas the Chinese markets have not.

According to analysis, socially responsible investment could account for 15 per cent of the UK stockmarket by 2009. What is your outlook for ethical investing?

Hollands: We have seen strong growth in our traditional ethically screened products, the Stewardship funds, and the responsible engagement overlay (REO) product we offer to pension funds. I believe demand is set to expand further.

First, surveys repeatedly show that investors are interested in ethical investment. What the industry needs to do is respond to that demand. The performance of the Stewardship funds shows that socially responsible inv-estment does not necessarily mean lower returns.

Second, in a post-Enron world, investors are waking up to the fact that social, environmental and ethical issues can directly affect a share price whether through reputational damage, litigation or pollution taxes and penalties.

Third, the direction of policy and regulation across Europe is putting pressure on investors to recognise that these issues should be part of their risk assessment of companies.

Potter: There is no question that socially responsible investing is increasingly becoming a more important issue in terms of investment solutions for clients. The major issues affecting the world right now make this debate even more high profile and I am in no doubt that current and future investors will be increasing, not decreasing, their desire to invest with good ethical and moral standards. Companies, industries and governments take note.

McDermott: We are supporters of SRI but we are not seeing an increase in demand for these funds. Analysis suggests that ethical investment has just topped 10bn for the first time but we are just not seeing that trend on the ground.

Is the recent turn-round in bond performance sustainable?

Hollands: Credit spreads widened in the wake of some major corporate downgrades from GM and Ford but have now snapped back and tightened again so recent performance is in part a normalising process after these events.

It is difficult to get excited about bonds when equities look more attractive on valuation grounds and dividend yields are so healthy compared with low bond yields.

With inflation rearing its head and event risk rising, it is hard to see bond markets making much headway.

Potter: If you had said a year ago that the US Federal Reserve would still be in tightening mode and that economic growth in the US would be higher than expected, you would not have said that bond yields would still be so low.

Indeed, many economists and market commentators argued this point at the start of the year. I believe that, following the fall in yields in recent weeks, bonds do look a little on the expensive side but I think it would be inconsistent, in the context of my global views, to expect a major fall from here and neither should investors regard the high-yield market as a one-way ticket like it has been in the last few years. That said, fundamentals for bonds look overdone, the market force that continues to drive bond prices is the liability matching that is going on, with pension and life companies still demanding bonds to match their future liabilities.

Is now a good time to be buying equities, bearing in mind the growth of the last two years?

Hollands: UK equities have returned more than 40 per cent over the last three years, yet many private investors have sat on the sidelines still smarting from losses made in 2000.

The time to have aggressively bought equities was earlier this year but, compared with competing asset classes and in absolute terms, equities remain a good bet. Markets have not been re-rated despite the better than expected performance which we have seen. This is due to the positive earnings’ surprises which have been coming through and have kept ratings relatively stable.

Potter: Clearly, equities have recovered over the last two years and do not make as compelling an argument as they did. Nevertheless, the old saying goes that “equities climb a wall of worry” and although there are many major issues facing the world right now, I would argue that relative to other options, they still represent one of the best ways of achieving long-term capital growth.

Economies are still growing, M&A activity is on the up, corporate cashflows strong, the newly emerging economies are keeping a lid on global inflation and interest rates are near to their peak. Be sensible though and buy the dips, as volatility will increase.

McDermott: Since the four-year bear market that we experienced at the turn of the century, everyone is nervous of recommending an asset class that has gone up but the economic fundamentals look good in the UK and this should support the market.

Companies have restored their balance sheets and are now making good profits – in some cases record profits. We still have the huge personal debt and rising oil prices as factors that are a worry. CFS believe that investing in equities is for the long term and are the main asset class that can deliver above-inflation returns over the long term, so we are happy for people to invest in equities.


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