The Investor Fund Manager Updates 2011

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The Investor|17Fund Manager updatesSt. Jamess Place fund managers report on the last quarter and discuss the future for financial markets around the worldThe views expressed in these updates are the fund managers own and St. Jamess Place accepts no responsibility or liability for the information they contain18 | TheInvestor F U N D MA N A G E R U P D A T E MANAGE DF UNDSIt is nowa little over three years since the US sub-prime crisis broke, precipitating the global financial and economic crisis. The monetaryauthorities worldwide have taken unprecedented measures to prevent the incipientfinancial collapse generating a global economic slump, and yetit is clear that profound and as yet unresolved problems remain.The current difficulties in the eurozone stemfroma toxic combination of misplaced economic fundamentalism, grosslyinadequate institutional arrangements and a lack of politicalwill and coordination. Emerging economies persist in their mercantilist approach, artificially depressing the external value of their currencies and distorting the balance between the traded anddomestic sectors of their own economies. As their inflationarypressures mount, that may require an unexpectedly aggressive policy response. Moreover, the credibility of the monetaryauthorities themselves is coming under a degree of scrutinythat we have not seen for many years.Despite these structural problems, financial markets generallyhave been buoyed by the combination of lowinterest rates, quantitative easing and the notable ability of corporations to reorganise themselves to recover profitability, generate cash andprovide themselves with the financial strength to weather what is an uncertain global economic outlook. That ability has providedmany market participants with a considerable degree of comfortthat the corporate engine on which the financial markets are builtremains in robust good health, despite the excessive debt burdens in the background.In such a confusing and uncertain global scenario, longer term value may be less evident, especially with clear signs of excessive enthusiasmin areas such as the emerging markets and parts of the bond markets. Nevertheless, those entities that are capable of generating moderate but consistent levels of growth may seem unremarkable at present but, in an uncertain environment of subdued global economic activity, such characteristics maybecome increasingly appreciated, providing a measure of immunity fromthe global background. Our recent visits to the USand Japan confirmthat Pfizer and Secomare just such examples.GAMThe mercantilist stance adopted by emerging economies may require an aggressive policy responseAndrew Green The credibility of monetary authorities is coming under intense scrutinyAXA FramlingtonWe remain overweight in industrials and underweight in consumer-related stocksThe final quarter of 2010 was a mixed one for markets. Equities moved nervously higher, butbonds finally succumbed to concerns that inflation maybecome a bigger issue and thatyields will eventually rise to more normal levels. The economic data was satisfactory, with better than expected numbers fromGermanyand the UK, a steadier performance fromthe US, but sluggish activityin the rest of Europe. Despite the better tone, the US Federal Reserve was taking no risks with the recovery and announced another boutof quantitative easing.Closer to home, the Irish were forced to accept a bailout package fromthe European Central Bank and the International Monetary Fund, and there remain serious concerns about the future of the euro and thatother countries will need support. Company results continued to meetor exceed expectations. There were no significant changes in assetallocation during the quarter. We remained overweight in UKequities reflecting their good yield, modest earnings multiple, faster earnings growth and the dominance of international businesses with goodgrowth prospects. We added modestly to US equities as the recoveryshould be sustained and growth could actually be above trend nextyear. There has been little change in sector preferences where we remain overweight in industrials and underweight in consumer-relatedstocks. We have, however, added modestly to financials, specificallyUKproperty companies, which look undervalued. The European authorities have probably done enough in the very short termto reassure investors, but another attack on the structure of the euro is inevitable unless more is done to correct the structural imbalances in a number of the smaller economies.Globally there are conflicting influences in terms of policy, with China and other emerging economies tightening monetary conditions, while the US and probably Europe are injecting liquidity into the system. On balance, we believe this background favours equities over bonds over the mediumterm, while in the shorter termthis tends to be a seasonally strong period of the year for equities.Richard Peirson There are serious concerns over the future of the euroTheInvestor | 19The spending cuts, whichthe government hope will helpeliminate the UKs deficit, cast a significant shadowover the outlookheading into 2011.Higher taxes will also place more pressure onthe domestic consumer.Abackdropwhere unemployment remains elevated, wage growthmutedandthe housing marketweakis likely to result intoughconditions for consumer spending anda general lackof inflationary pressure after the one-off impact of Januarys VAThike. As such, we seea prolongedperiodof weakgrowth inthe UKeconomy.We believe, however, that the domestic equitymarket contains a number of high quality businesses, with durable earnings prospects that are profoundly undervalued. The quality growth companies, whose consistent earnings and dividend growth have historically seen them trade at a premiumto the market, have experienced what we believe to be an unwarranted de-rating. However, this represents an excellentopportunity to gain exposure to these businesses.Companies in sectors such as tobacco, pharmaceuticals, utilities andtelecoms are not overly exposed to discretionary consumer spending in the UK, with many experiencing rapid expansion in faster-growing overseas markets. They typically have strong balance sheets and the potential to maintain earnings and dividends even in a period of modesteconomic growth. Despite this earnings resilience, they are among the cheapest stocks in the market, so we hold a high level of conviction in the prospect for the portfolio.Invesco PerpetualNeil WoodfordThe domestic equity market contains many high quality firms that are undervaluedArtisanDan OKeefe and David SamraDespite macro uncertainty, many of our companies reported solid earnings progress Irelandwas at the centre of attentionthis quarter. Its banking systemis in dire straits withtoo muchdebt anddeclining asset values: the legacy of its property boom. The Irishgovernment continues to recapitalise the banks andguarantee their liabilities. Concernedwithrecorddeficits, investors have grownunwilling to fundthe governments borrowings.Just as they didwithGreece several months ago, the EuropeanUnion hadto organize a sovereignbailout to stabilise confidence inthe euro. Fears that SpainandPortugal might go inthe same directionalso grew. Despite macro uncertainty, many of our companies reportedsolidearnings progress during the quarter. Signet Jewelers continuedto outperformthe industry andwas well positionedfor the big holiday season. The companyreportedexcellent thirdquarter results as same-store sales rose more than7%, margins increasedandthe balance sheet remainedstrong.Experian, Microsoft, 3M, Mastercard, AmericanExpress, Novartis, Ryanair, ArchCapital andTyco Electronics also reportedgoodearnings.The economic recovery is bringing challenges inthe formof higher costs. Some of our consumer goods firms, including Sherwin-Williams, are facing rising rawmaterial prices, andrises inmarketing expenses are characteristic of big advertisers like Procter &Gamble, Unilever, Diageo andAmericanExpress. Some of these firms will be better thanothers atpassing throughprice rises to offset price pressure. If the economycontinues to improve, these issues will be overshadowedby volume growth. If not, inflationwill take its toll onearnings, whichwe feel is partof the insecurity embeddedinthe cheapvaluations of these businesses.The performance of global equity markets has been muted in recentmonths as concerns about a financial crisis in Ireland resurfacedand spread to other eurozone countries such as Portugal and Spain.In China, inflation began to rise. To counter this, the governmentraised interest rates despite much of it being due to higher food prices.At the moment, the market is heavily divided between those stocks that have an emerging market exposure and those that are dependenton the West, where growth rates are much lower.In our UKportfolio, we hold mining companies and stocks, such as Burberry and auto parts maker GKN, that have picked up a significantbenefit fromthe tailwind provided by emerging markets, especiallyChina. We think, however, it is prudent to have a balance between these types of stocks and others such as banks, where growth is lower but pessimistic expectations have knocked down valuations to a veryundemanding level. The banking sector has recently been affected byproblems in the Irish banking system. While it is true that UKbanks such as RBS and Lloyds have significant loan books in Ireland, these have already been substantially written down. We believe UKbanks, which have hugely re-capitalised in the past two years, should be able to withstand the crisis and continue to offer outstanding value.With interest rates near zero and bond yields very low, we believe equities are likely to be the most attractive asset class for savers. There are clearly risks, principally the ongoing uncertainties in the eurozone and the biggest concern of all, Chinese inflation. Although we need to watch China closely,