derek stuart, manager of the artemis UK special situations fund, believes turnaround stocks are the safest play within the UK equities arena
Special situations funds are the lowest risk way to invest in UK equities, according to Derek Stuart of Artemis.
Stuart believes the FTSE 100 will have limited earnings growth potential as a result of a backdrop of around 2% GDP growth and inflation of 2%.
He said: 'Special situations stocks are the ones that are not pricing in expectations. So what is the risk? Would you rather buy a high-flying stock on a P/E of 40 times or a stock that has restructured?'
Stuart runs the Artemis UK Special Situations Fund, which over 12 months to 3 February has returned -21.63% after charges in the UK All Companies sector. This ranks it 12 out of 290 in the UK All Companies Sector, which provided an average return of -31.88%.
He said: 'I like companies where there has been a problem, turnaround companies and fallen angels. For instance stocks previously on big P/Es in the tech boom, which are fundamentally good businesses but where valuations have fallen back.
'Industry restructuring is another area I focus on. Where there is change I can make lots of money.'
Stuart in particular looks for a business with a strong franchise, with management change and evidence of internal recovery.
Speaking at the Investment Week Markets Forum in Edinburgh last month, Stuart gave examples of several companies in his portfolio that fit the criteria.
Future Network, a publisher of games magazines, is one such stock. Stuart said its name was ramped when it came to market with a £1bn market cap in 1999 but it subsequently over-expanded and when the advertising and tech markets collapsed it had a number of profit warnings.
He added: 'However, it is the largest games magazine business in Europe. It has new management, which is providing a steady pair of hands and it has had a rights issue so the balance sheet is not geared.' As a further example, Stuart cited Morse, a provider of servers and consultancy services to businesses.
He said: 'It has always had an excellent management team but I felt it was too expensive in the past.'
The stock price has collapsed since January 2000 yet Stuart feels the business has not fundamentally changed.
'It is still selling servers and has a market cap of £110m with cash of £80m. In addition the company is profitable. It will make £10m-£15m of operating profit and we have just had two-and-a-half years of downturn in IT spending,' he added.
Artemis UK Special Situations has some 8% of the portfolio in software and IT stocks. Stuart described these sectors as cyclical and said he is now able to buy into companies on valuations last seen in 1997 and 1998. He has a further 13% in building and construction stocks.
Stuart said: 'The prices reflect a crash in the housing market. Even if a crash takes place, these companies have got land and that is a scarce commodity.'
The final area of interest for Stuart is the media sector, where he expects to build up a 10% portfolio weighting. He characterises it as having undergone a massive downturn but valuations are now beginning to look very attractive.
Overall Stuart believes areas of the market offer significant value and corporate activity will pick up.
'In 1998 the people buying the market were companies' directors and in 1999 there were lots of takeovers,' he said. 'If the market does not recognise value then other people will. Please determine the difference between the share price and the company.'
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