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The bigger picture

Stock selection Samantha Downes reports that big firms are set to come to the fore this year as large caps bounce back.

It looks like being a big year for investors, with undervalued larger caps set to ride the predicted choppy markets.

F&C UK growth and income fund manager Ted Scott believes small and mid-cap companies have had it good for too long, with larger companies, particularly the so-called mega caps, largely ignored.

Scott believes big will be better in 2007. Although merger and acquisition activity will continue to bolster the FTSE All Share, an expected correction, possibly in late spring, will bring investors’ attention back to stocks such as BP, GlaxoSmithKline and Vodafone.

Scott says: “In the last six months, the market has been driven by merger and acquisition activity, which has been focused on smaller and mid caps. It is true that larger companies are immune from that. However, they are looking very cheap at the moment, with valuations very low.”

All it takes is a single correction, claims Scott, to turn attention back to the larger companies.

He says: “A re-rating of the FTSE 250 has been long overdue. For 10 years, the index has been at a discount but now it is the other way round.”

Stocks such as BP and Shell will be used as defences. The market capitalisation of Shell and BP is more than the FTSE 250 put together so their size makes them a sure bet if things get rocky, says Scott.

Neptune UK Equity fund manager Jeremy Smith agrees that large caps could come into the spotlight again, having languished since 2001’s market crash.

He says: “It has taken a while for investors to appreciate deflation. With low inflation, investors have moved down the index.”

Inflation-proofing a portfolio cannot do investors any harm, says Smith, even if there is no correction.

He says: “I think 2007 will be interesting. Lots of people expected 2006 to be the year of large caps but it was pretty much a repeat of 2005. We expect 2007 to be a totally different story.”

Smith points out that since December, mega caps such as Vodafone and Royal Bank of Scotland have been doing well and says: “This has happened when the markets have really been going nowhere.”

With larger caps starting to report improved earnings, interest will be revived .

Smith says: “The UK investment sphere is still earnings-based and institutional investors will be wanting to pile in as companies start to produce their year-end earnings, which at the moment are looking good.”

The success of medium and smaller companies in the last few years has helped reinvigorate large companies, particularly big retailers.

However, it is not all bad news for investors wanting to support smaller companies, says Scott. He predicts merger and acquisition activity will continue as potential buyers of smaller companies make further use of credit derivatives.

These are instruments which pool debt and allow companies to spread their borrowing. Scott believes this will continue to be a cheap and relatively risk-free means of borrowing.

The UK property sector is one area where fund managers are not expecting to produce great returns, regardless of size.

The launch of Reits could drive investors forward, although Scott says the conversion of big companies will not provide a substitute for some of the benefits of investing in property directly or in traditional open-ended retail funds.

Standard Life Investments director of mutual funds Barry MacLennan says UK property will stall this year. MacLennan, who is manager of Standard Life Investments’ select property fund, says he expects the UK market to cool this year. But he believes his fund, unlike pure UK property-themed funds, will be able to offset this through its increased investment in the Far East, which is at a younger, more dynamic, stage in its growth cycle.

His colleague Harry Nimmo, head of Standard Life Investments £229m UK smaller companies fund, is confident that, chosen correctly, smaller companies will continue to thrive, but stock selection is crucial.

He says: “We look for situations where we believe the consensus opinion to be wrong.”

At the other end, fledgling companies listed on the Alternative Investment Market have been underperforming.

Unicorn Asset Management Mastertrust fund manager Peter Walls says the index has something in common with the FTSE 100 in that they have both underperformed in 2005 and 2006. He attributes this to a peak in oil prices as well as former star performers such as SportingBet falling out of favour.

Walls says: “It did mean that some of the gloss came off some of the stocks. Yet if you look at our Eaglet investment trust, the asset value was up by 43 per cent and 40 per cent of that is invested in Aim.”

Eaglet’s star performers were Aim listed Debt Free Direct, the Jelf group, System Union and high-street slot machine company Talarius, whose share price went up by 84 per cent last year.

Aim is a volatile market and that is not set to change. “If your style is stockpicking there are still plenty of gems,” says Walls.

He attributes the success of the trust to its old-fashioned approach, saying: “We always invest in tried and trusted sectors. We do not invest in blue-sky companies, such as unproven technology and we always look to invest in companies paying a dividend or about to start doing so. We are quite traditional in that respect.”

Aim is still the most succ-essful growth market in the world. Walls says it will remain the domain of the niche investor.

He says: “Smaller companies are more risky and less liquid and they will suffer if there is a market correction. There will still be some dynamic companies that will end up listing on the main market this year.”

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