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Strong returns in the pipeline

Matt Goodburn canvasses fund managers for their short-term sector picks

The stockmarket has had a volatile summer following May and June’s correction and, with economic indicators not giving a clear picture of the market’s direction, picking the hottest sectors for the next 12 months is a challenge.

Barings head of UK equities Charles Deptford believes the main sectors to avoid are the more cyclical areas and stocks with big dollar exposure, such as the big pharmaceuticals, amid sustained fears of a US economic downturn.

He says areas with strong contractual repeat business could do well over the next 12 to 18 months and has increased his exposure to sports services companies. He believes that sub-sectors within financials are a good growth bet and is looking at brokers such as Icap.

Deptford says some of his more defensive blue-chip stocks, such as Diageo, Reckitt Benckiser and Unilever, could show steady growth although he cites their exposure to the US as a possible threat.

He says the major banks may outperform the market along with companies exposed to rising insurance premiums but with low dollar exposure, such as Admiral.

Deptford is negative about general retailing but more bullish about high-street retailing as he believes it will benefit from rising inflation. He also cites transport as a sector to watch. “I am optimistic about transport stocks such as Stagecoach and Arriva because it is an area looking forward to a reasonable amount of contract wins and is a sector with the potential for big corporate activity such as mergers and acquisitions,” he says.

Invesco Perpetual UK aggressive fund manager Ed Burke is wary of giving a short-term view because he believes such predictions are subject to sentiment swings. He says: “The US is a concern but generally I think stocks in most sectors do not look expensive and there is still reasonable value in big-cap stocks.”

Burke believes the telecom sector may offer the best bet in the short term and backs some of the sector’s biggest players to perform well in the coming months.

He says: “There has been a lot of concern about the telecoms market and we feel that you now have a number of companies in the sector that look good value.

“Vodafone has had its own bear market since 2001 and there have been more general concerns about mobile and fixed-line pricing. You now have a combination of low price to earnings ratio and strong cashflow. Fears over competition in the sector may also have been overblown.”

Burke has big stakes in HSBC and Barclays and believes the big banks may see some improving yields over the coming months.

T Bailey fund manager Jason Britton says the boutique firm has always had a general bias towards mid-caps over big-cap stocks but recently steered its fund of funds away from an over-reliance on mid-caps.

He does not pick out particular sectors for outperformance over the next few months but believes that all sectors of the FTSE may be liable to move up together so is moving into funds that that can deliver alpha over the coming months.

Britton says: “We have recently sold Ashton Bradbury’s Old Mutual UK small-cap fund and bought into the Schroders alpha plus fund.

“The case for the FTSE 100 outperforming the market is reasonable but not a certainty. We have done well from the FTSE 250 but now it is time to take some of that bet off the table.”

Martin Currie UK growth fund manager Jeff Saunders picks out electricity, oil and gas and mining as three sectors that should outperform the FTSE All Share in the coming year. His fund is 7.6 per cent, 6 per cent and 5 per cent overweight in these sectors respectively.

He says: “You are looking at a stronger for longer scenario. All these areas have benefited from increased demand and the general analyst view is that current prices cannot last for ever.”

Saunders cites the oil market where the price for West Texas oil is currently at $69 a barrel. He says there is a general analyst belief that the price will fall to around $55 by the end of 2007 and $45 by 2010. But if investors look at the futures curve, he says oil will peak at $75 in December 2007.

Saunders says: “We believe people are not good at recognising change. It is human nature that people take a while to believe conditions have changed and we think the sector will do well because there is a clear disconnect between what the market expects and the actual oil futures market.”

Similarly, Saunders expects the mining sector to outperform because there is a general consensus that prices cannot be sustained, which he says ignores the fact that there will be a stream of new sources of demand coming online, particularly from China.

He says: “There will be more demand and less supply. It has low costs and high revenues and is very cash-generative which means that it is relatively easy for mining companies to acquire others.”

Rathbone income fund manager Carl Stick says utilities have been good performers and will continue to benefit from worries over the security of energy supply domestically and abroad. He adds that the sector will continue to benefit from consolidation among European companies.

While remaining quite negative on the pharmaceutical sector , Stick has added to his oil and gas stocks. “We acknowledge the risk of further strength in the oil price,” he says.


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