Equities beckon for bravehearts

Published on 23/09/2012 00:00

Stock markets resemble bargain basements, but should we be lured from safety, asks Jeff Salway

Investors sitting on the sidelines and waiting for markets to pick up are missing out on one of the biggest growth opportunities in years, some experts ­believe.

Others err on the side of caution, wary of further volatility over the coming months. What is more certain is that, whether we’re in the midst of calm before the next market storm or the worst is firmly ­behind us, the current climate is a challenging one for 
investors.

So should you retreat to shelter until confidence returns or take the chance to buy in at low prices?

The former has been the favoured option in recent months. While the money has flowed into safe haven assets such as cash, gold, fixed income and absolute return funds, investment houses are reporting outflows from their equity funds.

Yet there’s an argument that with stock prices relatively cheap right now, investors will be rewarded for their bravery if they stay in the game.

Gary Potter, head of Multi-manager at Thames River, earlier this summer claimed that investor Equities beckon for bravehearts s steering clear of ­equities were missing out on “the buying opportunity of a generation”.

Of 44 world stock markets, 42 currently represent real value, according to New York-based Ned Davis Research. It pointed in particular to Europe, where markets are 40 per cent below their long-running averages, with Greece nearly 90 per cent down. ­Prices in Asia are cheaper than for some time too, following market falls over the past year.

Tom Munro, director of Tom Munro Financial Solutions, said: “With government debt in the UK, US and the Eurozone averaging around 90 per cent of GDP, it is inevitable that lower investment growth will follow, at least in the short to medium term.

“But amongst all this nervousness and uncertainty there are still some buying oppor­tunities for investors seeking both income and capital ­return.”

Jason Hollands, managing director for business development at Bestinvest, is more cautious.

“None of us has a crystal ball but risk assets have had such a strong run since June, particularly equities, so we think the ride ahead could be frothier,” said Hollands.

So where do the opportunities currently lie?

One answer, perhaps surprisingly, is the UK. Investors remain anxious over the UK economic outlook, but the appeal of UK equity income funds, that invest in companies with strong cash flows and which pay regular dividends, is enduring.

“We are in an environment where dividends are generally well covered by earnings,” said Hollands. “Yields on UK equity income funds are just over 4 per cent, which makes them attractive compared with corporate bonds, and the yield provides some comfort if markets pull back a bit.”

He particularly likes the Threadneedle UK Equity Income fund, up 20 and 37 per cent over the last one and three years respectively.

Graeme Forbes, chartered financial planner at Glasgow-based Intelligent Capital, also leans towards income-producing equity funds. “Good managers can put together a portfolio of good quality equities that yield around 4.5 per cent,” he said.

“When compared with bank deposits or gilts yields this is very attractive. Moreover, if these equities can grow their dividends over time, then the yield in a few years, based on the purchase price today, could be considerably higher.”

There are risks, as ever, one being an interest rate rise that would eat into yields. But with this not currently on the cards, dividend-paying stocks will remain key for some time yet.

If you want to be more contrarian you could buy into the beleaguered banking sector. While banks are difficult to put a value on, they are currently cheap, said Forbes.

“But it is hard to believe we will see an extended economic recovery at any time in the future without financials participating although a good deal of volatility should be expected,” he said.

Away from the UK, Southeast Asia still offers plenty of growth for investors happy to take a little risk. A marked slowdown in China has spooked investors, but with the economy growing at 6 per cent there’s an argument that it’s now at a more sustainable rate, according to Forbes. That could benefit other Asian countries. “Southeast Asian companies will continue to be beneficiaries of Chinese demand, and with a new political leadership due to take power soon, and likely eager to deliver a degree of hope and optimism to a wary populace, there is still a huge untapped potential that will drive profits for many businesses in the region,” said Forbes.

If you’re looking for something a little different, Hollands picked out funds that invest in infrastructure projects and which offer a solid income stream.

There are two types of infrastructure fund; those investing in actual, physical and operational projects and those that primarily invest in equities of companies that might benefit from such projects.

The former are the best bet, according to Hollands.

“These are typically very long-life projects which are already up and running and with future revenues backed by governments set up under the legal framework of private finance initiatives or public private partnership.”

In other words, the government is obliged to support deals it has already been committed to, giving investors stable and predictable revenues. Some projects also have contracts with in-built inflation protection, where annual revenue increases are written into the agreements.

“Our favoured fund is John Laing Infrastructure, currently yielding 5.4 per cent and trading at a 5.8 per cent premium,” said Hollands.

Pouncing on the best value opportunities is not just about picking the right funds and sectors, however. Returns are also shaped by the amount you pay in charges.

That’s why a growing number of financial advisers are recommending investment trusts, trackers (and other “passive” vehicles) and exchange traded funds (ETFs), all of which are usually cheaper than unit trusts.

For example, ETFs – which essentially track the performance of selected indices or markets – have annual charges as low as 0.15 per cent a year.

• Investors steering clear of stock markets are piling billions of pounds into corporate bonds – but even there they have to tread carefully. Government bonds – gilts – are seen as a safe haven, but with demand and quantitative easing pushing gilt prices up and yields down, corporate bond funds are attracting much of the private investor money going into the fixed interest market. Investment grade bonds, rated the least likely to default, have unsurprisingly proved especially popular. But this has its downside, says Jason Hollands, managing director for business development at Bestinvest.

“It has resulted in spreads tightening, so parts of the investment grade market look a bit stretched from a valuation perspective,” says Hollands. “We still think high yield is attractive, particularly where managers are keeping the duration quite short. Our favoured high yield fund is AXA Global High Income.”