Credit Suisse manager believes companies that generate cash for shareholders will be key
Investors would be foolish to ignore retail equity income funds during the coming consumer slowdown, according to Bill Mott, head of UK retail equities at Credit Suisse Asset Management.
Mott's view was outlined in a speech on the likely equity investment prospects for the near future at the Investment Week Markets Forum 2003.
He said there is a 70% chance the UK economy will face 'a gentle slowdown as the consumer gets glued up in his debt and goes from feeling fine to having a blocked nose'.
Over several years of anaemic growth as the economy's debt burdens are worn away, equity income funds will be the best UK equity asset class, Mott added.
He predicted if the gentle slowdown scenario becomes reality, equity income funds could be able to deliver investors returns of around 6% per year.
'This will not only be good in relative terms against the markets but also in absolute terms against returns available in cash and bonds,' he said.
UK cash returns would probably stay at their current levels of around 3%-4% and government bonds would probably continue to yield around 4%-4.5%, according to Credit Suisse.
Mott noted that for the whole of his 25-year career, equities have been valued by analysis of their growth characteristics.
'The reason we have done this is because we have had global growth,' he said.
'Now we are in a fascinating time for stock market investors in that the appropriate tools for valuing equities going forward will be totally different from the ones we have used in the past.
'The reason is that we are not going to get any growth, and equities will look quite overvalued on the normal growth analysis we are used to making.'
Mott forecast that as the consumer becomes caught up in unshifting debts within the new deflationary world, overall returns on asset classes will fall to the point where the dividend proportion of total return will be significantly higher, something that will also favour equity income funds.
He argued that with equity markets going nowhere and corporate profits no longer driven by consumer spending, investors will increasingly start looking at equities' ability to generate cash for shareholders rather than measuring them on a growth basis.
Mott said: 'In the UK, we are particularly lucky in that it is possible to select a portfolio of companies of all market cap sizes for which the yields on the dividends are attractive relative to the returns on cash and bonds. These are companies with stable margins, mature enough that they do not have to spend a fortune just to stay in business.'
He added this sort of company is more likely to be found in equity income funds because they are likely to have higher yields.
Mott added there is a 70% chance the economy will continue treading water. 'It will have to work hard just to keep its head above water.'
He believes there is a 15% chance the consumer will 'go from being completely well to having double pneumonia'. This would involve the air coming out of the housing market bubble and the Government attempting to ride to the rescue with emergency measures such as printing money.
If that were to happen, Mott said, equity investors would continue to outperform bond and cash investors, although they would still lose money. However, he cautioned, if the Government's rescue measures cause a sudden leap in inflation, the future direction of equities is anyone's guess.
Mott's AA-rated Credit Suisse Income fund is ranked three out of 69 funds in the UK Equity Income sector over five years to 1 January 2003.
Over that period, it has returned 33.27% to investors compared with a sector average of -4.76%, offer to bid with net income reinvested.
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