What Investment looks at the key issues that are driving the investment decisions of analysts and fund managers

UK investors may be receiving some respite from the relative weakness of the pound. Although sterling has rallied in recent weeks against most of the world’s major currencies, it is still at relatively low levels, and most currency market commentators expect sterling weakness to continue into the medium term.

This is a situation that has its positive aspects. As Martin Ellis, economist at Bank of Scotland, observes,‘UK shareholders in FTSE-listed companies declaring dividends in US dollars or the euro will get a significant boost to their returns when they convert their dividend payout into pounds. In the current business environment this is a very welcome development for investors paid in dollars or the euro.’

Currency gains
He points out that ‘The US dollar gained against the pound by 37 per cent between March 2008 and January 2009, while the euro increased in value by 23 per cent between January 2008 and January 2009. 30 companies listed in the FTSE 350 pay dividends in either the US dollar or the euro. In total, 40 per cent of profits and 31 per cent of dividends in the FTSE 350 came from companies that reported in US dollars during 2007.’

Illustrating the effect of these numbers in real cash terms, Ellis adds that ‘13 companies in the FTSE 350 reported total dividend payments of US$14.36 billion in June 2008. At that time, this was equivalent to £7.31 billion, but by January 2009 these same payments would have converted to £9.83 billion, 34 per cent higher, reflecting the appreciation of the US dollar between June and January.’

He concludes, ‘In March 2008, every 10 US cents of dividend paid was equivalent to 5p. By January 2009, the same 10 cents would fetch 6.8p. In euro terms, 10 cents of dividend payments bought 7.5p in January 2008, but during January 2009 this had risen to 9.2p.’

European bond revival
With yield now at the top of many investors’ agendas, attention is increasingly being focused on the bond markets, and Andrew Lake, co-manager of the F&C European High Yield Bond Fund, makes a specific case for European corporate bonds: ‘The European High Yield market has rebounded strongly from lows in November last year. Surprisingly, the riskier end of the spectrum, such as CCCrated bonds, has significantly outperformed the rest of the market.’

He explains, ‘The size of the European bond market means that large issuers have a disproportionate effect, so much of the CCC move can be explained by the rally in autos, particularly GMAC and GM. While there have been inflows into the asset class, much of the price activity is not representative of actual trading. Inventory is scarce as a result of paring back risk during 2008, and investors are reluctant to sell bonds that they have held down to current levels. Additionally,most investors are focusing on the same companies and sectors, adding to the liquidity problem that the market is facing at present.’

Lake points out that ‘Lack of a strong new issue calendar could result in the market continuing to tighten in the short term as investors have cash to spend. However, there will be significant market volatility this year and one should not be complacent over the current rally. There will be some recovery or stabilisation towards the end of the year and any market widening will lead to buying opportunities.’

He concludes, ‘Despite the bleak economic backdrop, there are still attractive opportunities at these levels.Telecom continues to be a good solid sector and telecom company Wind remains one of my top picks in Europe. I also like German cable companies as a core holding and remain positive on consumer non-cyclical stock. My focus is on companies at depressed prices that I believe will survive the downturn, in keeping with our strategy of gradually increasing risk in the portfolio for 2009.’

Bargains galore
In the stock market too, fund managers are beginning to have the confidence to go bargain hunting. Margaret Lawson, manager of the SVM UK100 Select Fund, insists that ‘it is time for shopping, not selling’.

She explains,‘In the very short term, markets could revisit the lows we saw last year, but there are encouraging indicators.The yield curve is now very positive, usually a sign that markets will recover, and there has been unprecedented stimulus for world economies that will be beneficial over the next one to two years.’

Lawson argues that ‘fiscal stimulus is only one part of the recovery.A comprehensive strategy of monetary easing and policies to restore stability in the financial market is necessary. Unless the financial system recovers, any fiscal stimulus will be of little help and the economic recovery will be protracted and weak.’

But the good news is that ‘After such severe asset destruction in the market, there are good buying opportunities.Valuations are compelling and dividend returns are attractive compared with bank deposit rates. There are, however, some sectors that will not improve during 2009, so it is important to remain cautious. Investors should focus on a company’s cash flow and its ability to pay a sustainable and growing dividend.’

Avoiding the debtors
Explaining which companies make it onto her ‘shopping list’, Lawson says,‘We are looking for companies with strong balance sheets that are not encumbered by debt and that will benefit from the stimulus spend in infrastructure, oil and gas. Given the correlation of oil demand to GDP, the outlook for the oil price is negative in the short term. But as demand recovers, prices will correct quickly, especially in light of recent investment cuts.’

She adds, ‘Oil remains an area of good opportunity over the next few years. There will also be good opportunities in selected financials, but currently the financial system is starved of capital and the private sector is unwilling to support further losses. There has to be a separation of good assets that have a future and will be supported by private investors, and bad assets that must be sold or temporarily taken under government control.’

Lawson argues that ‘Many companies will want to position themselves for the recovery, which could involve buying cheap assets.There will be rights issues from companies that are heavily indebted and cannot go to the banks, but also rights issues for companies that want to grow their businesses into the recovery. In view of the destruction there has been in share prices, we think investors will be well disposed to rights issues, and this will be an important theme for the equity market in 2009.’