US equity fund managers stick to stock picking in the face of high correlation

News - Funds

Written by Ray Clancy

Wednesday, 08 December 2010 11:15

Fund managers have been wrong footed by the exceptionally high correlation across stocks in the US market over the past year, but are hanging on to their stock picking style, according to the latest sector review.

‘High correlation was not predicted by fund managers a year ago. At that time, most fund managers expected company fundamentals to return to favour and that stock picking would become an important future driver of returns. As it has turned out, the market has shown little differentiation in ratings to reflect the quality or sustainability of future growth,’ said Simon Dorricott, lead analyst at S&P Fund Services.

He explained that there have been only small pockets where this has not been true. IT stocks related to the hot theme of cloud computing, and small/mid-cap IT names where some valuations appear to include a bid premium following recent M&A activity, according to the report published by S&P Fund Services.

It points out that portfolio managers are now less certain of when the market will start to fully reflect fundamentals, rather than the macro driven risk-on/risk-off moves that have been seen. ‘What they do all agree on is that the current situation cannot continue indefinitely and indeed some, including Old Mutual, Melchior, and MFS, have pointed to a short term improvement over the past couple of months,’ it says.

In the face of these market conditions, fund managers are generally sticking to their established stock picking approaches. However, some have put more emphasis on large cap quality growth names that offer international exposure and sustainable growth.

Others have focused more on stocks where they have identified very significant growth potential in the expectation that these differentiated returns will eventually be recognised and fully rewarded by market participants.

It gives as examples Jeffrey Lindsay and Edward Dowd of the S&P AA rated BlackRock Global Funds US Growth Fund, Jeff Morris on the S&P A rated Standard Life Investment Funds - American Equity Unconstrained Fund, and Bill Stewart and Mark Phelps on the S&P AA rated WP Stewart Holdings Fund.

The report adds that fund managers are generally positive on the outlook for the US equity market. Favourable levels of corporate profitability and valuation, with operating earnings estimates for the S&P 500 at near 2006 highs and a relatively low market rating by P/E ratio, indicate potential upside, they point out.

Free cashflow levels are high and capex relatively depressed, while debt levels are low (relative to assets) compared to history. Managers also agree that high levels of cash held by corporate America should also feed through to investors in the form of dividends or buy-backs, but will also result in increased capex and M&A activity.