Why equities will beat bonds' 'minuscule' returns

Derek Stuart and Ruth Keattch, co-managers of the Artemis UK Special Situations fund, a pick of Citywire Selection, say investing in equities is a better bet than buying bonds and hoping Western politicians get their acts together.

Investors overlooking attractively valued equities

Artemis UK Special Situations manager Derek Stuart says many investors are overlooking what he sees as the current attractive valuations of many equities, and are instead looking for ‘minuscule’ returns from fixed income.

‘The equity story is under-appreciated in bond land, where many investors are getting minuscule yields with no growth which is all propped up by central banks,' Stuart said.

‘We would rather own equities which can grow at three, four or five per cent. Why would you bet on the politicians of the Western world when you can bet with a number of fantastic chief executives who have already steered their companies through a crisis?’

Awaiting M&A action

Stuart, who manages the £1 billion fund alongside co-manager Ruth Keattch, is also looking to a renewed surge in merger and acquisition activity to drive portfolio performance this year.

The fund saw bids for five of its companies in 2010, but none last year, and Stuart is optimistic that this year will see more bids, with several stocks in the portfolio already looking like being involved in bid activity.

Pharmaceuticals becoming growth stocks again

With Stuart expecting the unwinding of debt in Western nations to be a ‘multi-year issue’ he is wary of being too exposed to UK firms that have a pure public-sector or domestic consumer business model. But at the same time he is eyeing a number of stocks in sectors he believes have reached an attractive stage in their cycle.

One such example is the pharmaceutical sector, where GlaxoSmithKline (GSK.L) is the fund’s second largest holding (4.25% at the end of January), with AstraZeneca (AZN.L) making up a further 2.6%.

In common with Jan Luthman, Stuart believes the sector is in the process of transitioning from a defensive to a more growth-orientated one.

‘In my time in the market, pharma has gone from growth to deep value, and it is now heading back to growth again. You could pick it up several years ago on 25 times earnings, it was on nine times last June and it is [still at] 11 times so there is much less downside risk,’ Stuart said.

Looking for 'fallen angels'

As a manager who seeks out 'special situation' stocks, anticipating changes in sentiment towards stocks and sectors ahead of the broader market are what he likes to do best, seeking out what he considers sound companies that have fallen out of favour with investors.

‘There is a cycle for every sector, and I love buying the growth stocks that have become fallen angels. There is nothing as satisfying as buying a stock that all the analysts hate and then watching those sells move to a buy,’ Stuart said.