Expert share tips for defensive investors

By Philip Scott
Updated:

 

Richard Watts, the incoming manager of the hugely successful Old Mutual UK Select Mid-Cap fund, talks to This is Money's Phil Scott about his top stock picks.

Richard Watts

Hard times: Old Mutual's Richard Watts doesn't expect much economic joy but asserts that there are opportunities to be found

Since its inception, in February 2002, Old Mutual's UK Select Mid-Cap fund has regularly topped the UK fund charts after delivering stellar returns to its investors.

Under the guidance of Ashton Bradbury, who selects his bets from the mid and small-cap universe of the FSTE 250, the portfolio has posted growth of 83% (until the end of October 2008) leaving the index well behind with its 31% increase. The average UK All Company fund is up a mere 1% over the six-and-a-half year period.

But the Old Mutual fund has not been immune to the market downturn - over the past 12 months it has endured a 41% collapse.

The FTSE 250 has fared worse dropping more than 45%. Its peer group average has fared slightly better with a 38% fall.

The group admit that the recent fall back in performance was as a result of its commodity related stocks which 'suffered'. And the fund is about to change hands too – a situation which can typically rattle investor nerves.

At the start of 2009 Bradbury will step down from his responsibilities to take a seat on the board at the group as well as taking on the broader role of head of equities. His co-manager for the past two years, Richard Watts will take over the reins.

'It will be business as usual. My aim is to maintain the portfolio's track record,' asserts Watts, who has been with the group for the past six years. 'But it is an interesting time to be taking over the fund.'

'It is quite clear that we are in, or heading for, a sychronised global recession,' he says. 'The question is "how deep will it go?" But at this stage it is too early to compare it too other recessions.'

Watts is all-too well aware that investor nerves have been shaken and the portfolio has accordingly been positioned defensively to ride out the market storm. 'There are opportunities out there. Next year, the key will be about getting the sector calls right and clearly the same will apply to stock selection.'

What are his tips?

Watts says the fund's current top 10 holdings typically carry the 'defensive' qualities he is looking for, as well as a visibility of earnings. Presently, he favours support services firms, which are benefiting from the trend towards outsourcing. He also likes aerospace and defence which offer visible growth.

The fund's largest holding, which makes up a modest 2.8% of the portfolio is support services company Babcock International, which operates primarily within public sector institutions. Over the past 12 months, its share price has dropped by 30% to 434½p. The group works extensively with the UK armed forces and has business across Europe, Africa and North America.

Watts says: 'This is a defensive business with long-term contracts in place and because it has an order book, it gives investors good visibility of future earnings.' A similar holding, also among the fund's top 10 stocks, is VT Group – which is down 21% over the past year. The group has three primary divisions: marine products, services and shipbuilding.

He says: 'It presently runs the naval base in Portsmouth and has long-term contracts in place, therefore it has that visibility of earnings alongside the potential to grow these earnings as it re-negotiates contracts.'

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Utilities are a classic defensive play and Northumbrian Water, in which the fund has 2.5% invested - its second largest holding - is no exception. It provides essential services such as water collection, treatment, distribution, sewage treatment and disposal. 'You really can't get any more defensive than with a firm like Northumbrian Water as it has that certainty of income behind it,' says Watts. Over the past 12 months it is up 1% to 308¼p.

Another services firm favoured by Watts is Serco, which has suffered a share price fall of 22% to 359½p over the last year. The group, among others, manages research laboratories, local education authorities, leisure centres and prisons. Its business also includes the operation of London's Docklands Light Railway and air traffic control towers in the Middle East and across America. Again, its chief unique selling point for investors is the certainty of earnings that the contract-led business has.

Aerospace and defense stock Chemring, down 19% to 1692p, specialises in defence manufacturing, producing decoy measures, such as flares, to protect air, sea and land platforms against guided missile threats. 'Orders can be more ad-hoc but much of what the group provides requires regular replacement,' says Watts.

Another typically defensive play, which also makes up part of the fund's top 10 holdings is De La Rue – the world's largest commercial security printer and papermaker. It currently has contracts in place for more than 150 national currencies across the globe. Over the last year it has grown by 5% to 847p a share.

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Elsewhere, Amlin, (up 3% to 354½p) an insurance underwriter at Lloyds and Greene King (down 57% to 368¾p) the brewery, behind beers such as Abbot Ale, IPA and Old Speckled Hen, are responsible for almost 4% of the fund between them. Brewers have had a difficult time of late, burdened with the fallout from the smoking ban and heavy debts. But Watts says: 'We think Greene King is at the more resilient end of the consumer spectrum. It has debt on its books but not at the level as say Punch or Enterprise Inns, which we have avoided. JD Wetherspoon is also among the stocks we hold.'

Victrex, down 19% over the past 12 months to 565p, manufactures patented hard wearing, temperature and chemical resistant plastic, which fundamentally works as a substitute for metal. Customers include electronics companies, car makers and aerospace groups. 'Around 50% of the top-line turnover is Euro denominated – which helps given the comparable weakness of sterling.'

Rounding off the top 10 stocks is oil producer Premier Oil, which Watts admits 'has not been the best performer, but its share price is cheap versus the sector'. Over the last year its share price has fallen by 35% to 725½p.

Overall Watts doesn't expect to see any positive economic news until at least mid-2009. The fund presently holds 64 stocks – markedly lower than the 80 it had in the summer - but in the future he predicts that he will typically carry between 65 to 75 investments.

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