Royal leads the list of the lame for 2008 re-rating

ROYAL Bank of Scotland badly let down the Scrutineer share portfolio this year, with a fall of 33 per cent. F&C Asset Management also disappointed with a 7.4 per cent fall, as did SVM UK Active Trust (down 7.1 per cent).

Two outstanding performers – Vodafone (up 32.7 per cent) and property group Halladale (up 32.7 per cent due to a takeover bid) helped the portfolio to a gain overall of 2.6 per cent. Adding in the 3.5 per cent yield and the total return over the year is just over 6 per cent.

What of 2008? I am going for broke with a selection dominated by some of 2007's worst performers. Chief among these are battered house builder Barratt Developments, down 65 per cent from their 2007 high, badly mauled up-market estate agency Savills (down 60 per cent) and insurance giant Aviva (down 22 per cent).

I have also included TR Property Investment Trust (down 35.5 per cent) for a diversified exposure to the commercial property market, with the added attraction that the shares are standing at a 17 per cent discount to the underlying value of the shares in the portfolio. I have included Forth Ports at 1,930p offering good prospects in 2008.

Many will recoil at a selection dominated by companies in the most unfashionable and unattractive sectors. Quite so. But better, surely, shares that have discounted some of the problems ahead than those standing on a premium of undelivered hope. And as the august Investors Chronicle reminds us, a strategy of buying shares that are least popular with City analysts tends to work well. In 2006 such a portfolio rose by 30 per cent over 12 months, outperforming the FTSE 350 by 7 per cent over the same period.

There are also more fundamental reasons. Interest rates are on the way down, with further reductions to 4.5 per cent widely expected. That won't prevent damage to company earnings and performance in 2008. But it holds out the prospect that investor sentiment will be in better shape by the end of the year than it is now.

The most difficult decision has been what to do with Royal Bank of Scotland. In ways that many may prefer to forget, 2007 has been a transformational year. Its dramatic convulsions this year have sharply polarised opinion. Few in business Scotland do not now have a strong view about RBS – a company unfairly tarnished and whose shares are an outrageous buy, or a bank that has ridden roughshod over shareholder value, and whose shares should be avoided. Which view is right?

In buying Dutch banking giant ABN Amro, RBS led the biggest-ever takeover by a UK banking group, at a highly controversial price and for benefits that may take longer to deliver than the template acquisition of National Westminster suggests. And it has been badly damaged by the continuing convulsions of the global credit crunch. Recently announced write-offs of some 1.5 billion are unlikely to be the end of the matter. Shares in RBS were down 45 per cent at one point this autumn from their 2007 high. At today's price of 444p they yield more than twice the FTSE Actuaries average, at 7.3 per cent. That, say the sceptics, is as much a warning as an invitation.

Set against this are some big positives. The ABN acquisition gives the group enormous strategic opportunity round the world. And in bringing significant new earnings it brings the textbook antidote to credit crunch shocks: diversification of earnings by activity and geographic source. RBS is also a powerful revenue generator. And it has outstandingly courageous leadership in Sir Fred Goodwin. This storm will pass. And as it does so RBS will come in for a substantial re-rating.

I lean to this second view, though with the caveat that there is bad news still to come for the banking system and the recovery in confidence will take some time. However, for the present, the shares are underpinned by a strong yield and also by the possibility that RBS itself could be the target of strategic stake-building by a Sovereign Wealth Fund at this level.

Though the overall average yield is 5.15 per cent, this is a selection for the brave, and it runs the risk of being far too early in the cycle. But investor expectations are everything. If it pays off, I can don a tweed jacket, bow tie and goatee beard and present myself at Gogarburn as the Emeritus Professor of Behavioural Finance. If it fails, I will join a large number of slumped beggars in the Canongate, fulminating to every passer-by and rattling our lager cans with our epitaph etched in cardboard: "Backed Sir Fred. Please give generously."