Every economic cloud has a silver lining

The Government is set to slash public spending but there are always bright spots on the horizon. Julian Knight investigates

It's hardly a secret, but an unprecedented squeeze on public sector spending is about to take place to help reduce Britain's mammoth deficit.

With the NHS and international development spending ring-fenced, some departments could, eventually, see their budgets fall by anything up to 25 per cent – and that's without the further hit of inflation currently running at over 5 per cent a year. Job losses are inevitable, as are cutbacks in consumer spending; and there is the chance that if cuts are too deep, the economy could slip back into recession. This is doom-laden stuff, but when it comes to investing, there is always a winner when there is a loser, a flipside to every story.

When it comes to public sector spending cuts, the same is true, it seems. There are businesses set to benefit and fund managers well placed to make a killing. "Even with major cuts, there are companies and sectors which should come out of it pretty well," says Mick Gilligan, a partner at the stockbroking firm Killik & Co. "Take outsourcing companies, for instance. The Government is going to want to move stuff off its balance sheet, which means employees being transferred from the public to the private sector. This is where outsourcing comes into play," he adds.

Mr Gilligan identifies five major companies in the outsourcing sector which have potential for growth. "Capita, Serco, Mitie and Mears should all attract additional business, but this is already priced into the stock; Capita, for instance, is trading at 19 times its revenues, compared to a FTSE average of 10.5.

"However, the fifth outsourcing company, Interserve, is an interesting proposition; it is involved in the construction industry, which has suppressed its share price, so it's trading at five and half times revenue but is paying a dividend of 3 per cent."

Food retailers may also do better, as people focus on the basics. "The Marks & Spencers of this world may not do quite so well, and the same goes for the electrical retailers, but I'd expect core food retailers to be OK. Tesco, for instance, is very well placed for more austere times," Mr Gilligan adds.

David Kuo, director of the financial advice website Fool.co.uk, says the shift back to basics will encompass clothes, too "I see Primark, owned by Associated British Food, as a potential winner, despite its recent unappetising dividend payout."

In difficult times, Mr Kuo says consumers often fall back on simple pleasures: "Smokers may trade down, but they are unlikely to give up the habit. So tobacco firms and cigarette makers should continue to enjoy buoyant sales. Consider Imperial Tobacco and British American Tobacco. Both pay dividends of more than 5 per cent." Gambling is also a potential growth area: "More people are likely to chance their hand when times get hard. This bodes well for bookies which could see a boost in both internet traffic and footfall," Mr Kuo adds. Pawnbroking firms, which have already had a strong recession, may continue their growth.

More conventionally, the ring-fencing of NHS spending could provide a fill-up to the pharmaceutical sector: "People are still going to get ill [which] puts pharmaceutical companies in an enviable position," says Darius McDermott, managing director at Chelsea Financial Services. GlaxoSmithKline and Astra Zeneca are standouts in this sector identified by Mr Kuo.

Elsewhere, utility companies – gas, electricity and water – are often seen as a safe haven in a storm. "These companies enjoy a regular stream of revenue, which makes them particularly attractive in tougher times. Centrica, National Grid and United Utilities look attractively priced," Mr Kuo adds.

If the Government does get to grips with the public sector deficit and interest rates start to rise – which seems likely, as they are currently at a historic low of 0.5 per cent – then the pound should strengthen, which is something investors should build into their calculations when deciding where to look for investment growth: "It is obvious that austerity is not good for most corporate sectors. But it will be good for the value of the pound, so firms which import most of their raw materials will do better," says Jane Foley, research director at the currency broker Forex.com. "Sectors which could benefit from this could be transport companies which import oil, gas companies and utilities; but remember many of the firms that import also export, so manufacturing, for example, may see little benefit from an appreciating pound," she adds.

Investors nervy about investing may do best identifying a fund manager with a track record of steering a profitable course through difficult times. "Funds spread risk by offering a more diversified exposure to the market; one manager with a enviable record and positioned in sectors that may do well is Neil Woodford's Invesco Perpetual UK Equity Income Fund," Mr Gilligan says. A fan of this fund, Mr McDermott also likes the look of the Framlington Health Fund and Artemis Strategic Assets Fund managed by William Littlewood. "I like the fact that his fund uses futures extensively, so he can make money when share prices and currencies actually fall. At times like these, when we are looking at a new austerity, it's important to look for a manager nimble on his feet and able to take advantage of short-term shifts in the market, as well as someone like Woodford who buys and holds good, dividend-paying companies for the long term," he says.

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