UK growth fund managers see end of cyclical rally, says S&P

In a welcome reversal of the trends of 2008, investors in UK growth funds made money in the three months to the end of May, according to Standard & Poor's Fund Services.

'Funds that moved away from defensive positioning and took on more cyclical exposure did best,' says S&P Fund Services lead analyst Alison Cratchley, citing as examples the S&P AA rated BlackRock UK Special Situations Fund and the A rated Fidelity Investment Funds - Special Situations fund.

'Both these funds owed their above-median performance in 2008 to their defensive positioning,' says Cratchley. 'However, since late 2008/early 2009, both managers added more cyclicals to their portfolios. The increased cyclical tilt has led to continued above-median returns.'

Despite this, even managers who participated in the cyclical rally think that it has gone far enough. Cratchley points to Trevor Green at New Star, who told S&P Fund Services that further re-rating of cyclical shares would require evidence of earnings stability, or even improvement.

'Looking ahead, managers think defensive stocks are looking cheap,' says Cratchley, pointing to Stephen Peak at New Star and Karen Robertson at Standard Life as examples.

'While Robertson expects a cyclical rally in the fourth quarter, she thinks that, at these levels, defensive stocks like Vodafone and tobacco companies look cheap.'

Managers are typically divided on the outlook.

'Most agree that the deterioration in economic data has slowed,' said Cratchley, 'but there is no consensus on whether this represents the beginnings of recovery or just a short-term rally.'

Sanjeev Shah, manager of the S&P A rated Fidelity Investment Funds - Special Situations Fund, thinks the worst of the economic recession is over but the market may experience a short-term correction. In contrast, Peter Michaelis who manages the S&P A rated Aviva Investors Investment Funds - UK Ethical Fund, thinks a reduction in both private and public spending will result in fewer companies with strong earnings growth in the future.

However, the current atmosphere is not all bad news. Peak believes that the level of fear in the market remains high and fear causes investors to make mistakes, creating opportunities. Peak aims to exploit these opportunities through valuation-driven, bottom-up stock selection.