Aiming high is the key to SLI's approach

Equities have made a good start to 2005, particularly in the UK, where they have continued the rise that started last autumn when markets finally broke out of their trading range. That move was triggered by a series of good quarterly corporate results and indications that the oil price was returning to more normal levels.

Since then, the housing market has displayed symptoms of a slowdown in demand, and this, in turn, has prompted interest rate expectations to ease. Even when combined with the delayed impact of higher energy costs, which hit consumer price inflation in November, and increases in both transportation costs and utility bills, inflation is still below the Bank of England's 2% per year target. That is good news for UK investors, explains Karen Robertson, manager of the Standard Life Investments UK Equity High Income fund.

"We believe that all of the elements are in place for a period of moderate economic growth in the UK and its major trading partners," she said. "Corporate earnings growth is expected to slow this year to about 10% pa, but the environment should remain positive for equities, particularly UK equities."

Robertson, who has been a member of the highly regarded UK team at the Edinburgh-based asset management house for almost 15 years, is charged with delivering a dividend yield at least 10% above that of the market.

She is also tasked with achieving top-quartile performance relative to the IMA UK Equity Income sector.

The fund aims to give a high level of income with some capital growth over the longer-term. It invests primarily in high yielding UK equities but may also include lower yielding stocks which have the potential to deliver capital growth.

"The fund is what we call a high conviction stock picking fund," Robertson explained. "Unlike some other funds, we do not have to own a stock purely because it is represented in the FTSE All-Share index. In addition, the fund's sector positions do not have to mirror the sector breakdown of the index. Meticulous stock selection is key - the fund is based on the UK equity team's 50-60 strongest stock ideas."

Robertson added, "We do not call ourselves a value manager or a growth manager as both styles have merit at different times in the economic cycle. For instance, during the last couple of years value styles have worked well, however, for the previous couple of years, growth styles were more effective."

Investment managers at Standard Life Investments aim to outperform the market regardless of economic environments. They do so by employing a philosophy referred to as Focus On Change.

She said: "We believe it is change that moves share prices. We look at several areas including earnings revisions, management change, industry consolidation or company restructuring. Using thorough analysis, we are trying to predict change ahead of the market as we believe there is a strong correlation with subsequent share price performance."

"We go about that in two main ways. Firstly, direct company and fundamental research - the fact that we have around 800 company meetings a year - and secondly, by our stock selection matrix. This is a technical, quantitative tool that we've put together to screen stocks. Basically what we're trying to do is identify cheap companies where we see the outlook improving.

"Each of the fund's holdings is large enough to have an impact on the overall performance. Our robust stock selection process aims to identify improving situations which are not fully recognised by the market. Our process includes company visits, consideration of earnings momentum and traditional valuation measures."

Clearly, it as an effective tool, as the performance of the UK Equity High Income fund testifies. In 2003, it returned 28.74% to outperform the sector by around 7.5%. And, proving that was not an isolated good year, the fund delivered growth of 22.16% in 2004 against a sector average of 16.21%.

Those performances continued a series of consistent returns that have enabled the Fund to comfortably outperform the median over the longer term.

Robertson is confident that 2005 will be another good year for investors in the UK Equity High Income Fund. She said: "With free cashflow still strong, growing yields, buybacks and special dividends should prove supportive."

She is particularly optimistic about the telecoms sector, most notably mmO2, which is well placed to prosper, with a low valuation, good prospects for double-digit earnings growth and increased dividend payments. Robertson is also upbeat about domestic banks, given the low valuations and a generally improving outlook for earnings. Her preferred stocks in this sector are Barclays, RBS and HBOS.

She believes that the resources sector is another that should do well. One of the side effects of the tumbling dollar has been upward pressure on global commodity prices.

"Resource-based companies have been supported by strong global demand, especially from emerging economies," she explained. "During 2004, the sector - most notably mining stocks - performed strongly, and is poised for further rises. Valuations are still cheap and commodity prices have not yet peaked. Currency fluctuations and uncertainty over the pace of economic slowdown in China will ensure there is volatility in the sector, but we expect it to provide good relative returns in 2005."

In retail, Robertson expects Marks & Spencer to perform well, although the company may face some short-term trading difficulties. Like-for-like sales are set to increase this summer once the new management team starts to influence the stock in the stores. Bid speculation is likely to remain in the background.

Within the FTSE 350 index, her focus is on smaller, undervalued companies where the outlook is improving. National Express, BPB, Aga and Cookson all fit the bill in this respect and should produce positive returns.

fund manager

Karen Robertson is manager of the UK Equity Growth and UK Equity High Income funds.

She also manages the UK Equity General Life fund and Unit Trusts.

Joined Standard Life as UK investment analyst in 1990 after graduating in Economics (BA Hons) from Strathclyde University.

She is an Associate of Society of Investment Professionals (formerly AIIMR).

key points

After rising sharply at the end of 2004, UK equity markets continue to offer good prospects for investors this year.

Strong cashflow promises dividend growth and possible share buybacks.

Telecoms, banking and resources stocks should perform well.