Fund Managers Are Buying Defensive Shares To Counter A Downturn.
By Paul Farrow, Personal Finance Editor | 20 September 2010
According to the latest Bank of America Merrill Lynch survey, professional investors have returned from their summer breaks in a less than buoyant mood. Many are approaching the fourth quarter with a heightened sense of caution, increasing their cash positions and buying shares that have defensive characteristics. Fund managers are building up defensive positions in their investment portfolios because of fears of a double-dip recession in many economies.
The survey coincides with pessimistic views from Neil Woodford, one of the most listened-to fund managers in Britain. He said life was going to be very tough and that the chances of the country falling back into recession next year had increased. Mr Woodford's concerns echo those of British businesses, many of which said in a survey last week that they also thought that Britain was heading for a recession.
But investors are not discounting shares despite this pessimistic outlook. Many reckon that equities are a better bet than bonds at this juncture— and it all boils down to yield. The yield on equities is currently higher than on bonds, something that rarely happens. But when it does, it often suggests that equities are a bargain.
Put simply, a yield is the income from an investment, expressed as a percentage of the price. The higher the income in relation to the price, the better the value of the underlying investment— and vice versa. Analysts and fund managers study the relationship between the gilt yield and the equity yield religiously to examine how cheap or expensive shares are compared with government bonds. The closer they are to each other, the better value equities are reckoned to be.
Stock market bulls ask: what would you rather get— a 1.7% fixed return on five-year gilts, for instance, or a 3.3% return on equities, with growth thrown in, over the long term? Before 1959, equities continually yielded more than gilts because they were perceived as more risky. But in the Fifties and Sixties the perception began to change as the major pension funds started to invest in shares.
The pioneer of this new direction is considered to be George Ross Goobey— often called the father of the equity cult— who started to take the Imperial Tobacco pension fund into equities in the Fifties. In 2003, when equities also yielded more than gilts, it turned out to be a defining moment. The FTSE 100 had fallen to 3,487 but within days it started to reverse its fall and never looked back until the financial crisis hit in 2007, by which time it had climbed to 6,725.
Although many analysts are in no doubt that equities offer great value, they advise investors to expect a rocky ride— the past few years have been unprecedented. Equities may be cheap, but not all shares and sectors will deliver. The global economy is slowing again, while corporate and consumer debt is still at worryingly high levels.
Mr Mott has built his Income fund with a heavy bias towards large companies with strong cash flows that he hopes will do very well in a 'bracing' environment. His fund is full of stocks in the pharmaceutical, utilities, telecoms, tobacco and food retail areas. "These same companies should cope successfully in the event of a double-dip recession thanks to their defensive qualities," he said. "Such companies will also have pricing power in an inflationary environment."
Outside the FTSE 100, Mr Mott holds Booker, Dairy Crest, Premier Farnell and Rotork.
Fund management groups have tried to capitalise on investor nerves with new funds. M&G recently launched a corporate bond fund that aims to keep pace with inflation. Many financial advisers welcomed the fund, but few said they would be recommending it to clients because it was untried.
Last week Fidelity launched its Equity Growth Defender, which sets out to protect 80% of the highest value the fund reaches without the use of derivatives, although it offers no guarantees. If the fund price moves up, driven by higher share prices and effective stock selection, equity exposure will be increased. If the fund price falls, its equity exposure will be reduced and cash increased.
Darius McDermott of Chelsea Financial Services said:
Adrian Lowcock of Bestinvest said it was the quality large-cap companies that looked most interesting on valuation and yield grounds. He tipped fund managers such as Tony Nutt (Jupiter Income), Nigel Thomas (Axa Framlington UK Select Opportunities) and Colin Morton (Rensburg UK Equity Income). "They have been investing in high-yielding large-cap stocks with strong cash flows. And Bill Miller of Legg Mason US Equity has gone as far as saying that US blue chips are the bargain of a lifetime," he said.
It Is Not All Defensive
Amid all the talk of going defensive, fund managers in the Merrill Lynch survey expected stronger growth in China over the next year, a sharp reversal from the pessimism of recent times. A net 11% of the managers surveyed expected China's economy to strengthen, which marks a 30% swing and the biggest positive move since May 2009. [[Which means that it's probably about time to get out of China stocks.: normxxx]] If it's China you're interested in, advisers' favourites include funds from Jupiter, Neptune and Gartmore.