Professional Investor: Solid is better than seductive in UK equities

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The Independent Online

There is a tendency amongst commentators to write off the prospects of UK equities, particularly in a global context. The economy is said to offer only limited growth prospects and is far too exposed to an over-leveraged consumer. But I would advise investors not to be beguiled by these bearish stories.

I experienced this negativity at first hand three years ago in Asia. I had accepted a transfer to London to become head of UK equities with the task of reinvigorating the investment process to focus on fundamental company research. Many of my peers thought I was crazy to move from the exciting, developing stock markets of Asia to the dull, mature UK market.

But I took a different view. Whilst the economy may not have the plethora of attractive economic statistics and demographic figures that have enticed people to invest in the Far East, I concluded that, as with all equity markets around the world, there would be opportunities in the UK to make money for clients. Indeed, my previous 10 years in Asia taught me that a company could be based in a country with the gloomiest of economic prognoses only to have a stellar share price performance.

Now I have been proved right. Although the performance of FTSE 100 companies has been solid, rather than spectacular, with the index providing a return of 38 per cent, mid-cap stocks have more than made up for this. During the past three years, the FTSE 250 (excluding investment trusts) index has returned 76 per cent, narrowly outperforming the "racy" Asia ex-Japan stock market.

Perhaps I was fortunate to arrive in the UK near the bottom of the market cycle and have experienced only the upside. But to my mind, just as in March 2003 company fundamentals had been ignored by the majority of investors, the UK corporate is in good shape today, despite stories of an over-borrowed consumer and collapsing house prices.

For me, UK quoted companies possess several environmental advantages to their global peers. Management teams are generally high quality, accounting standards are robust and transparent, regulation is mature and the Government - with some notable exceptions - is favourable to market-led solutions.

Against this backdrop, the FTSE All Share is a poor proxy for the UK economy. Many large index constituents that we invest in, such as BP, Royal Dutch/Shell, Rio Tinto and BAT, have very small direct exposure to the fortunes of UK plc, while others, such as Unilever, Prudential and HSBC, have substantial overseas operations that are the growth engines of their businesses.

Investors in UK equities can, therefore, benefit not only from the transparency and strong management of companies domiciled here, but also from these firms' operations in faster growing and more profitable markets overseas.

That's not to say that companies can't make money operating solely in the UK, and there are some great businesses that do just that, especially among the mid-cap sector. The underlying financial position for many UK corporates is also robust, with debt levels substantially reduced from the heady days of 2000, and companies now looking to return the large amounts of surplus cash generated to shareholders via buy-backs, special distributions and increased regular dividends. Centrica, for example, has done all three, increasing its dividend by 59 per cent in 2004, announcing a substantial ongoing buy-back and making a special payment out of the proceeds of its sale of the AA.

Underlying a favourable operating environment, overseas opportunities and strong finances lies the fact that valuations in general, despite a strong recent run, are also not demanding.

Two companies that sum up the opportunities for long-term investors in the UK market are the retailers Mothercare and HMV. You may think I am mad, but these companies look attractive and pick up the positive themes I've outlined.

The UK may lack the seductive stories of the Far East, but it is home to many well-run companies, with opportunities at home and abroad to create and return real value to shareholders in the long term. For investors prepared to do their homework, there are chances to make money here.

Chou Chong is head of pan-European equities at Aberdeen Asset Management.

cash@independent.co.uk

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