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Voyage of the Beagles

The past eight weeks have seen an incredibly strong rally in global stock markets. For example, since the Standard Life UK equity recovery fund – which I featured in these pages – launched in early March, it has risen by 50 per cent. That is an astonishing move in such a short space of time but should we all now jump on the bandwagon?

I find it hard to believe markets will not pull back again and, in my view, extreme pessimism has given way to unfounded complacency. Despite this I remain a fan of equity income funds, particularly as interest rates are likely to stay low for quite some time. The JO Hambro UK equity income fund has a realistic yield of around 6.3 per cent, in the opinion of its manager Clive Beagles, which includes the prospect of dividend cuts of around 10 per cent during 2009.

The recent move in the market has been led strongly by cyclical companies, that is, those whose fortunes are more closely tied to the UK economy. Beagles felt that analyst forecasts were so dire that firms only had to perform marginally better in order to give the market a positive surprise, which seems to be what is happening.

The UK’s economic situation is serious but he believes we will emerge from recession relatively early for three reasons. First, the UK has the highest number of variable-rate mortgages and therefore the domestic market is hugely affected by the reduction in short-term interest rates. Anyone on a tracker mortgage has saved a lot of money over the past year.

Second, we have seen a massive devaluation in sterling (greater than in 1992, when we were unceremoniously dumped from the ERM) which makes our exports more competitive.

Finally, the UK contains only five banks, which Beagles argues now appear to have been largely sorted out, whereas in the US they have 6,000 banks which are by no means out of the woods.

There are several key themes that Mr Beagles has running through the portfolio. One tactic, which others are also warming to, is to focus on companies benefiting from their weaker competitors going bust. Surviving firms have, by default, a much bigger market share. This includes insurance, following the demise of AIG, packaged holidays, like TUI Travel, and music retailer HMV, which has profited from the death of Zavvi and Woolworths.

Some companies are also able to benefit enormously from interest rates that are virtually at zero – these include commercial property companies such as British Land and Land Securities.

Mr Beagles is also underweight traditional defensive companies on the belief that their valuations are at an historic high. This is interesting as many others managers believe they look extremely cheap – as the saying goes, that’s what makes a market.

Beagles is also underweight oil, with the exception of a decent position in BP. The portfolio does have a slight tilt towards cyclical areas, which has certainly been the area of the market that has been very profitable over the past few weeks. Plenty of companies are up by more than 100 per cent but the manager has not been afraid to sell shares when they have given him a healthy profit despite not generally being a short-term trader.

It makes a change to see a more bullish fund manager who strongly believes shares are cheap versus bonds. My own worry centres more on the fact that I do not believe this is quite the same as the start of the bull market in 2003. Although the world economy does seem to have avoided an Armageddon scenario, which at least justifies some kind of market rally, it feels like too much too soon for me.

However, the one glorious thing about an income fund is that, while the capital will fluctuate, the income will offer a healthy boost to your return and, even accounting for dividend cuts, the JO Hambro UK equity income fund offers a superior income to most other types of investment.

Mark Dampier is head of research at Hargreaves Lansdown

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