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Aegon Ethical Equity Muse

Tuesday, 13 May 2008 by Matt Ayres | 0 Comments
Ethical Equity Muse - AEGON Ethical
March 2008

The first quarter of 2008 was volatile by any measure with the FTSE All-Share falling just shy of 10%. Mid-caps fared best, down 5.5%. Industrials and mining performed well over the period, as did some of the financials, including real estate and banks. Telecoms lagged, along with technology and the retailers.

The Ethical Equity Fund performed strongly in the first quarter of 2008, outperforming the Lipper UK All Companies median by 4.38% and achieving a first quartile position. Over one year the fund is second quartile relative to the Lipper UK All Companies sector. The outperformance in the first quarter was evenly split between sector allocation and stock selection.

The underweight position in the oil majors (BP and RD Shell) and the overweight exposure to the oil services sector boosted returns. The fund also benefited from the overweight stance in support services and electronics & electricals, and the lack of exposure to pharmaceuticals and food retailers (the fund cannot invest in either sector, given the ethical criteria). On the downside, some performance was lost from the underweight exposure in mining and real estate and the overweight in mobile telecoms (Vodafone). The underweight exposure in banks and household goods (includes Reckitt Benckiser and housebuilders) also hurt as these sectors rallied.

At a stock level, the winners included Aquarius Platinum (rising platinum prices as supply tightened) and Wellstream (continuing positive news on pricing and contracts). Homeserve and Connaught (the social housing and compliance business), also continued to perform well as did Expro (takeover talks indicated) and BG. The stock laggards included HSBC (not investable), Southern Cross (growth concerns and management departures), Rio Tinto (not eligible), Informa and Go Ahead Group.

During the period we further reduced exposure to the housebuilders (sold out completely of Persimmon and Bovis Homes) and added to general financials through Intermediate Capital, the mezzanine finance player that will benefit from the current financial turmoil and Prudential. Other positions that were exited included Entertainment Rights, Southern Cross, Informa and Cable & Wireless.

In terms of current thoughts, we continue to urge caution on the UK consumer and the domestic economy. We remain concerned that the strain on banks’ balance sheets will have significant repercussions for credit availability for the consumer and corporations alike. This will have consequences for spending levels that have not yet been fully reflected in current earnings forecasts. Hence, the fund’s underweight position in the banks and real estate sectors and our caution on general and housing related retailers and housebuilders. We continue to monitor closely the underweight stance in these sectors given the underperformance, however, we still feel it is too early be adding in this space.

The risks to UK growth are to the downside. We expect growth to be slower than the consensus and interest rates and the currency to be lower than the consensus. Getting the sector calls right was all-important in 2007 as the market came to terms with the macroeconomic outlook and started to price in relative earnings risk. In 2008, we are likely to see stock picking within sectors return to the fore as the winners and losers emerge.

Lest we become too downbeat, it is important to remember that the UK equity market is not representative of the UK economy. Approximately 65% of the sales made by FTSE 100 companies are overseas. With a faster policy response in the US, resilient growth in Asia and a weak currency, the stockmarket may continue to favour London-listed companies that have very little to do with the UK.

In our 2008 UK Equity outlook, we anticipated a volatile year for equity markets and expected the market to decline before recovering in the second half of the year. With one quarter behind us, the FTSE All-Share is currently around 5% lower and valuations are now looking more attractive. The stockmarket has already discounted significant economic weakness and will anticipate the recovery before it actually happens. However, the prospect for recovery has been pushed out by the continuing financial crisis. Meanwhile, consensus profit estimates remain stubbornly high. US recessions historically see earnings fall by around 20% against the current expectations of 6% growth. The risk is that the equity market goes lower from here before recovering once the extent of the profits downturn becomes clearer later in 2008 or early in 2009.

We continue to focus on stocks that have a good earnings growth profile and strong balance sheets. We have been adding to stocks in the large-cap arena in order to capture more defensive and internationally exposed growth business. Our preference for stocks exposed to growth coming from the BRIC economies (Brazil, Russia, India and China) as opposed to those with western exposure, remains intact.

Audrey Ryan
25 April 2008

What now?

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