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Weigh to go

After three years of stockmarket losses and high volatility, it is not too difficult to understand why a lot of investors are reluctant to put new money into equities.

While investment comparisons tend to concentrate on fund performance, for many investors, the only comparison that makes sense right now is the return they can get from their building society account.

They look at the success or failure of their stockmarket or bond investments by asking whether their rock-solid savings account would have done better. But with UK interest rates recently cut to their lowest level since 1955, only the most risk-averse investor will find the lowly returns from a building society account particularly attractive.

Market turbulence has driven some investors towards bond funds, with the promise of fixed returns against a backdrop of global uncertainty. However, such has been the outperformance of bonds during the last three years that we believe investors could be missing out on some good opportunities if they shun equities completely.

In the cautious managed sector, our present tilt towards equities is a reflection of the view that equities are more attractively priced than bonds, with plenty of bad news already priced in to the FTSE All Share index at present levels.

The valuation argument is worth expanding on. As fixed-income investments, we know precisely what earning stream a bond will give us in the years ahead. But the dividend yield on UK equities is now similar to that of gilts while making no allowance for the effects of inflation over time.

Provided that we can identify shares in companies that are not likely to cut their dividends, we consider there is a fairly solid case for favouring equities.

It is important to take a fairly discriminatory stance rather than simply piling in across the board in the way that a tracker fund would do. It would be a mistake to adopt the view that, just because the FTSE is a long way off its high, everything must necessarily be cheap.

Sometimes, shares are cheap for a good reason. Some companies&#39 ability to generate cash has been hampered by corporate belt-tightening over the last few years. Many companies have made strides in improving efficiency through cutting costs but it is worth remembering that one firm&#39s cost cut is usually another&#39s revenue cut.

In the UK, thanks partly to the feelgood factors of rising employment, low interest rates and soaring house prices, the consumer sector has been particularly buoyant but has shown signs of cooling over the last couple of months. In choosing stocks, we are targeting highly cash-generative companies where the valuation fails to reflect either the underlying value of the business or its potential to grow but without too much exposure to the most discretionary of consumer spending.

Obviously, a good yield is a further benefit. Firms such as Boots and Hilton have got very solid business bases, generate cash and yet still yield over 5 per cent. In short, we are focusing on companies that have got defensive qualities with an earnings&#39 growth angle, too.

From an asset-allocation perspective, our tilt towards equities is a stance we are comfortable with at the moment. But, given high market volatility and lingering global economic and political uncertainties, it is not a stance we are wedded to.

Our objective is to exercise prudent judgement to strike the most appropriate balance between equities and bonds. In this light, we will adjust weightings as and when our outlook changes.

There is a lot of liquidity around the market at the moment and we believe that sentiment – and the stockmarket – will pick up in the shorter term as we get some kind of resolution to the Iraq situation. However, from an investment perspective, even in the event of an early end to the likely conflict with Iraq, the war on terrorism may have further implications for markets in the medium term, with consumer sentiment still vulnerable to fears of terrorist reprisals. In this event, the security of bonds would plainly become much more attractive again.

Over the medium term, we are going to have to see an improvement in the economic and company earnings&#39 environment for a stockmarket rally to be sustained.

We believe that a balanced fund, combining the security of bonds with the potential capital growth of equities, should appeal to a wide spectrum of investors.


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