Playing cautious in UK equities

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With world markets enjoying boom conditions, I thought it was time to review my investment strategy for the year ahead. In 1993, my own portfolio was fully invested, with about 65 per cent in the UK, 20 per cent in South African gold shares and 15 per cent in Hong Kong. All three areas were very successful.

I am now planning my portfolio for 1994 and, at this moment, intend to invest 20 per cent in gold shares, 25 per cent in Hong Kong, 40 per cent in the UK and the balance of 15 per cent in cash or near cash.

In the UK market, I still prefer companies with strong cash flow, very little debt and low price/earnings ratios in relation to their double-figure growth rates. Their low PEGs (price earnings growth factors) provide the prospect of an upwards status change in the p/e ratio, in addition to gains coming from the above-average growth in their earnings. The low PEG also provides some protection against a possible big downswing in the market as a whole.

I will be investing only 40 per cent in the UK market because there are better bargains in Hong Kong and I am beginning to feel just a little uneasy about the UK market as a whole. Unemployment has been falling since January 1993 and long-term interest rates in America appear to be turning up. UK retail sales are higher, art galleries are doing better, residential property values are rising - all are signs of greater prosperity trickling through into the economy.

After perhaps one more cut in interest rates, the Government will not be too worried if it has to increase rates a little, especially if unemployment is falling at the time. The market has had a good rise since I wrote about the case for a continuing bull market in March 1993 and again in October.

An alien landing on Earth would not now be tempted to invest a large proportion of his portfolio in the UK. However, I still like to keep my hand in here and capitalise on local knowledge, so 40 per cent of my portfolio seems about right to me.

For my 20 per cent in gold, I still favour South African mines, in which you can buy a large number of ounces in the ground very cheaply indeed. However, in 1994 I am counter-balancing the political risk with an equal amount in Australian gold plays. If civil unrest breaks out in South Africa, gold will soar in price and South African gold shares will suffer. In that event, Australian gold shares would benefit both ways.

The other main area I like is Hong Kong. As regular readers of this column know, I favour shares with the following characteristics:

Chinese management.

Exposure to China's highly competitive manufacturing facilities and massive potential retail market.

Insignificant debt.

Low p/e ratios.

Very high estimated future growth rates.

Red chips are an anomaly

You might think that these kinds of companies (often called 'red chips') stand at a premium to the market as a whole. Strangely enough, the reverse is the case - the leading stocks are on an average multiple of over 15, whereas many red chips can be purchased on prospective multiples of under 10. An absurd anomaly that will, in my view, correct itself over the next few years as more and more investors realise that the prosperity of the leading companies is essentially linked to the future of Hong Kong itself.

In contrast, the red chips should benefit from China's growth almost irrespective of Sino-British politics. I am therefore increasing my Hong Kong red chip portfolio and will be writing much more about China plays in the coming year.

The balance of 15 per cent in cash or near cash simply reflects my slight uneasiness about the future course of markets after such a good year. I may modify this either way as 1994 unfolds.

The author is an active investor who may hold any share he recommends in this column. Shares can go down as well as up. Mr Slater has agreed not to deal in a share within six weeks before and after any mention in this column.