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Fund managers positioning for volatile UK growth outlook, says S&P

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Some managers of UK growth funds are at last beginning to see better times ahead after another dismal quarter, according to Standard & Poor’s Fund Services in its latest update on t

Some managers of UK growth funds are at last beginning to see better times ahead after another dismal quarter, according to Standard & Poor’s Fund Services in its latest update on the sector, but most managers remain cautious in their outlook.

According to S&P, in general managers expect volatility to continue. Many forecast a difficult next three to six months, with dividend cuts, rights issues and earnings downgrades likely in a number of sectors. However, there were some exceptions to the general gloom.

‘One of the more positive managers is Harry Nimmo of the Standard Life UK Smaller Companies Fund,’ says S&P Fund Services lead analyst Alison Cratchley. ‘He thinks we are seeing the beginning of the end of the bear market, based on the significant reduction in base rates and the high level of director buying. He expects a dramatic turnaround some time in 2009.’

Noting that Nimmo expects the market turnaround to be led by recovery stocks, Cratchley points out that he would be unable to reflect that view in his portfolio because of his focus on quality stocks.

Simon King, manager of the Gartmore UK Focus Fund, believes that perhaps the most important decision of 2009 will be when to move away from more defensive names towards financials and cyclicals.

Some managers have already started that move. Richard Watts and Daniel Nickols at Old Mutual have reduced exposure to late cyclical industrial companies and added to early cyclical consumer companies in the general retail and travel and leisure sectors.

At Standard Life, two managers are following contrasting strategies. Karen Robertson of the Standard Life UK Equity Growth Fund has sold a number of cyclicals, such as HMV, Weir Group and Cookson Group, where she expects earnings downgrades.

Meanwhile, Ed Legget of the Standard Life UK Equity High Alpha Fund believes that the bad news is already discounted in the price of some cyclicals. After taking a more defensive position in October, he reversed it in November, adding to cyclicals with perceived strong balance sheets and franchises such as packaging maker DS Smith. He also moved overweight in early cyclicals such as Kesa Electricals and HMV and travel & leisure (TUI Travel). 

Looking back at the final quarter, S&P Fund Services’ figures show that even the most resilient mainstream growth funds lost money for investors, with Investec UK Special Situations Fund down 1.1 per cent over the quarter and down 19.3 per cent over 2008, compared with a loss of ten per cent for the median mainstream fund during the quarter and 31.1 per cent for the full year. This relative outperformance was due mainly to a focus on large-cap defensives such as BP, GlaxoSmithKline and Unilever.

Among S&P Fund Services-rated smaller companies funds, the top performer was the Old Mutual UK Select Mid Cap, with a decline of 11.8 per cent for the quarter and 30.7 per cent for the full year. This compared with the median fund losses of 21.6 and 39 per cent respectively.

Sector positioning accounted for around three-quarters of the outperformance and stock selection for most of the balance. A recently established overweight in non-life insurance contributed positively, as did overweighting aerospace and defence, where Chemring performed particularly well.

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