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7 October 2002

Defensive McLeish remaining cautious

Ian Mcleish, fund manager of The Scottish Investment Trust, believes high oil price is a negative sign for the world economy in the future.

Scottish Investment Trust manager Ian McLeish is cautiously upbeat on the outlook for economic recovery.

McLeish believes cheap equity valuations mean investors can now get in on the ground floor to gain maximum upside exposure.

The impatience of trust investors for performance means managers cannot simply start loading up on growth stocks, with the possibility of a prolonged wait before recovery arrives.

Accordingly, McLeish is maintaining a defensive position on the £953.0m trust, which has returned -10.2% on a share price basis over the 12 months to 23 September, compared to the global growth sector average of -8.1%, to rank 20 in a field of 32.

In the UK, which makes up 46% of the portfolio, McLeish is overweight in homebuilders, tobacco and water stocks, while in Europe, which comprises 12.2%, he is heavy in construction and pharmaceuticals.

"We will be less defensive when we are more confident that we will see more rapid growth in economies," he said.

"Growth companies are very vulnerable when they do not achieve the growth they expect. It is worse to be in a company that expects 10% growth and gets 5% than one that is geared for 2% growth and gets 3%."

McLeish said he is content to forego the initial rapid gains expected once the market grabs hold of the recovery story.

"The first part of any rise in markets can be quite spectacular and it is quite easy to miss out on that, because you don't know where the bottom is going to be. That is just an insurance policy you have to pay for, " he said.

However the gearing on the trust, currently around 19%, will enable it to make the most of the uptrend once the market turns, he said.

Economic recovery is likely to be gradual given the level of debt being carried by consumers and corporates, reducing their ability to amplify any upswing with additional borrowings.

"We would expect to see the economy grow again but at an awfully modest rate," McLeish said.

"One of the gloomiest things I see is the price of oil - a high oil price very often precedes difficult economic conditions and if oils stays high for a lot longer, I think it will lead to problems."

Overall, McLeish doubts the prospects for deflation and is confident of mild economic growth next year. "It will take a while before markets believe this but in the meantime valuations have come back to much more sensible levels. In the longer run, this should represent an attractive opportunity but I am not suggesting it is about to turn in the next few months," he said.

McLeish said equity investment is still attractive when compared to safe-haven plays like bonds or bank deposits paying very low yields. The trust's UK portfolio is trading on an average multiple of 11 times earnings, equivalent to an earnings yield of 9%, and dividend yield of just under 4%, compared to current bond yields of around 4.5%.

"I don't know what is going to make people move back into equities but on a longer-term basis this has to be a reasonable entry point, because you have got genuine fundamental value," he said. "Even if you have to wait a year or two, at least you are getting some income on your shares."

Blair Speedy
Investment Week
www.ifaonline.co.uk