Since the start of this year we’ve broadly wanted to combine two themes in the portfolio. The first has been structural growth: companies that can deliver good earnings growth even in a fairly anaemic environment for western economies. The second has been a more economically sensitive component that can keep us in touch, or give us gearing, when the market is stronger, particularly in response to central bank or political events.
More recently, we have reduced the degree to which the Fund is exposed to industrials, taking the view that the global industrial environment seems to have slowed. Conversely, we’ve increased – from underweight to neutral – our retail stocks. Two things have become apparent. Firstly, the consumer environment is arguably less negative. Also, when we look at forecasts for a lot of retail companies they are very conservatively pitched, which offers scope for those companies to beat expectations.
If we take a step back and think about where we are likely capture the strongest returns over the longer term, some of the sectors that we’ve particularly focused on have included areas like software, electronics and media. This is because – certainly in the smaller companies’ field – those are the areas in which we feel we’re likely to get companies with strong structural growth dynamics. Another area that has interested us over the course of this year is the UK house building sector, which we think is a special situation backed up by the idea that the environment is becoming somewhat less competitive.
Looking to what are likely to be the key investment themes in 2013, the fiscal cliff will dominate thinking of the balance of 2012, but as we look forward I think we’ll face the same sorts of questions that we always do. In respect of the outlook for economic growth, we can see signs of modest improvement. In prospects for corporate profitability, our sense is that forecasts are if anything becoming a little bit more realistic. The third thing we need to be mindful of is market valuation, and if we look at the UK All-Share index it’s trading on around 10.5 times, which is again still some way below the 13 times that has been the average level seen over the past 20 years. For me, that adds up to a cautiously optimistic outlook for 2013.
Daniel Nickols is manager of the Old Mutual UK Select Smaller Companies fund