Life has become somewhat easier for the beleaguered UK equity income fund manager. For those fund ma...
Life has become somewhat easier for the beleaguered UK equity income fund manager. For those fund managers who run their portfolios with the 'value' tilt which has predominantly been the domain of the income fund manager, the change in sentiment about the global economic outlook in 1999 and genuine signs of a recovery in Asia and Japan has led to vicious sector and size rotation. This is typical of this stage of an economic cycle and provides favourable conditions for income funds.
Although the median income fund still trails the index in 1999, it has outperformed the median growth fund and the investment landscape has been much more conducive for all investment styles to be able to flourish. While there have been some strong performers among the top 10 companies in the market, notably HSBC, oil stocks, Vodafone and Barclays, stock performance has been much more broadly spread than in 1997 or 1998. Only two FTSE 100 stocks (Billion and Telewest) feature in the top 50 performers of the FTSE 350 year to date with the rest being equally spread between value cyclical plays (consumer and industrial) and growth stocks.
Looking back, the loosening of monetary policy by both the Fed and the MPC provided the turning point for compressing the valuation band that had stretched to its limits last September between long duration stocks (telecom, pharmaceuticals and technology) and value plays (industrials, resources, consumer cyclicals). Investors who ignore economic fundamentals, specifically directional change in interest rates and GDP forecasts, will have found it difficult to make the necessary portfolio switches to ensure that good performance in 1998 was not thrown away in 1999.
The HSBC Income Fund has benefited from its bias towards mid-250 stocks which were sensitive to economic recovery in the UK and we increased the fund's exposure to industrials and general retailers throughout the fourth quarter of 1998 and the first quarter of 1999. Purchases of Next, Signet, British Steel, BPB and Bowthorpe have all provided upside in 1999.
Where we were slow to adjust the portfolio was in reducing our exposure to value defensives such as foods, utilities and life assurance. While we sold Legal & General, United Utilities and Powergen we remained overweight in utilities and life assurance, sectors that have significantly underperformed in 1999.
The lessons of previous interest rate cycles suggest a pro-cyclical bias in portfolios still has mileage for outperforming the market. While the easy part of the cyclical trade is usually the compression in an over-stretched valuation band, the second leg of outperformance usually comes as upgrades start coming through. Operational gearing works both ways and with the Fed seeing the need to tighten interest rates only modestly, the MPC probably still having a modest bias to easing and survey data in the US, UK, Europe and Asia all pointing to accelerating demand the profit outlook for GDP sensitive companies in 2000 is much brighter than investors envisaged just a few months ago.
The more benign economic conditions suitable for traditional UK equity income investing will last into 2000. Although the equity market no longer looks cheap relative to bonds there are still pockets of value in the FTSE 350 Index.
Tim Russell is head of UK equities at HSBC Asset Management
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