Investment Report
2005 looks set to be a year of consolidation. It seems unlikely that there will be a dramatic move in the stock market but we are confident that the stage is being set for a strong run over the course of the next couple of years.
Our investment themes - broadly unchanged since we reported to you six months ago – reflect this cautiously optimistic view of the stock market. The focus of our investments continues to be those companies which we believe will benefit from an increase in corporate expenditure. There has been a delay in the corporate expenditure cycle, due to uncertainty and fear stemming from the war on terrorism and high profile corporate collapses, despite a prolonged period of historically low interest rates. However, the last fifteen months of stability in the stock market has allowed investors and company management to regain confidence putting in place the conditions conducive to corporate expenditure. We have positioned clients’ portfolios to benefit from this anticipated trend.
One sector that we feel will be a prime beneficiary of an upturn in corporate expenditure but which has remained out of favour with investors since the market peaked at the turn of the decade is the software sector. Two small market capitalised companies that we like in this sector are Invu, which specialises in document management software for small and medium sized enterprises and Kewill Systems, a provider of supply chain management solutions for corporates. Both companies have strong management teams and are projected to generate significant free cash flow (as a percentage of turnover) which will help underwrite future growth.
It is interesting to note that the sectors that remain out of favour - media, telecoms and pharmaceuticals – are those that suffered heavy losses following the market peak. We think these sectors now look undervalued and include some attractive investment opportunities. We particularly like the media stocks Reuters, a global news service and Pearson, an educational publishing business and owner of the Financial Times and Penguin books. Both companies were prompted to undertake extensive internal restructuring and cost cutting initiatives following a period of declining revenues. Revenues have now stabilised and we believe that these companies will surprise the market on the upside leveraging growth from their significantly reduced cost base and high operational gearing.
Elsewhere in the UK we like cash generative companies such as GlaxoSmithKline and Vodafone where investors have benefited from generous share buy back programmes. The UK clearing banks, Lloyds TSB and Barclays, are also appealing as we think they are attractive targets for larger US financial predators. There are currently over US$100 billion of bids outstanding in the US and there is clear evidence of an upward turn in merger and acquisition activity globally.
We have also sought exposure outside the UK to areas which we believe offer the opportunity for higher growth, such as the Emerging Market economies. The Aberdeen New Dawn Investment Trust is our preferred investment vehicle in this area. It has shown good historical performance, in part because of the manager’s astute geographic allocation (it has a high percentage weighting in India where the stock market is at an all time high). In the recent results announcement the company highlighted the high level of dividend income paid by many companies in which it invests, by paying a special dividend to shareholders. This represents an important milestone in the development of the emerging market economies. India (and China) has a large population and a high ratio of young workers to elderly people and therefore has the capacity to undertake large-scale engineering and infrastructure projects in its drive to modernise the economy such as a complete modernisation of the railways. This is attractive to Western investors who are helping fuel growth in the emerging markets by increasing investment in these areas.
At this time we are not fully invested but we will be seeking further investment opportunities after the summer lull. Looking ahead to the end of 2005 and on into 2006, we believe the portfolios are well positioned to benefit from a pick up in the stock market.
30 June 2005
