What has been happening on the UK equity markets this year?

UK equities have generated a modest return of over 2 per cent so far this year following the Spring dip and the volatility of the past few weeks. However, with the recent monetary tightening and the general re appraisal by the market of the direction of interest rates, bond yields have shifted out further . This has had a couple of knock on effects in the market, with some of the higher duration and traditionally bond sensitive areas underperforming quite sharply, and in this I would include Real Estate, Banks and Utilities. The secondary impact was for the market to reassess the outlook for economic growth as a result of these interest rate rises, which has led to weakness in General Retail and other consumer exposed areas of the market.

While much attention has been focused on the possible contagion effects of the sub prime lending situation in the US, there has as yet been little feedback to the UK market, with the only wobble perhaps witnessed by Northern Rock, which has seen the cost of securitising its lending book rise.

The now familiar theme of M&A activity has continued, both from corporates and from private equity, and it is perhaps reassuring that some of the larger deals consummated have been from corporates, witness Hanson and Heidelberg, Thomson and Reuters, and ICI which turned down a bid from Akzo. Of the private equity deals, Alliance Boots was one of the larger, and it looks like the long running saga for EMI is close to completion. The other saga, the first attempt at European cross border deal in banking, still rumbles on.

Looking at the UK stockmarket over the next 12 months, what do you think the key influences will be?

Valuations look reasonable to us so we would expect the market to make more progress over the next 12 months.The underlying picture is for the UK and Global economy to remain relatively healthy this year although the impact of rising inflation and higher interest rates will be salient and may moderate the rate of growth with conditions in the United States and China particular areas of focus. Overall we expect that corporate earnings should remain robust and although borrowing costs have risen, the brisk level of M&A activity that we have seen looks likely to continue driven by both private equity groups and companies themselves. Continued bid speculation also increases the pressure on companies to return excess cash to shareholders either through share buy-backs and/or increased dividends. This should hopefully offset any slowing in dividend growth elsewhere in the market as companies exhibit a healthy level of prudence.

Do these conditions point you towards certain sectors which you think are more interesting than others?

Our whole investment style is driven by our own fundamental stock research, rather than taking a top down view of which sectors may prove more attractive. In parallel with Aberdeen, these private equity and overseas buyers identify undervalued companies with healthy cash flow and strong asset-backing operating in growing markets. Consequently we have unintentionally found ourselves investors in many bid for companies and there is no reason why this trend won’t continue. In some of the more homogenous sectors, where we find a number of attractive opportunities where we can find well managed businesses at attractive valuations, the natural outcome is to end up overweight in that area, eg Life Assurance. Given the income nature of the Trust ,we are also attracted to companies that are able to provide healthy dividend growth for example the likes of BT and British American Tobacco, as well as some higher yielding stocks which have fallen out of favour in the market place for whatever reason and which now, to our minds, provide an interesting valuation opportunity, and an example of these , perhaps surprisingly, would include the Pharmaceutical stocks GlaxoSmithKline and AstraZeneca.. This is very important to us when running a Trust that has grown the dividend it pays to its investors in each of the past 26 years.

How do you decide which stocks to buy for your portfolio?

Whilst the Trust is co-managed by myself and Charles Luke it really is a team approach drawing on the experience and expertise of Aberdeen’s Pan-European team. Our bottom-up investment process begins with a few basic rules: never invest in stocks the team hasn't visited; never feel obliged to buy a stock because it appears we should (because it's big in the index, say). Team members conduct hundreds of company visits per year then duly document these meetings and undertake rigorous analysis of the business model.

We avoid businesses we don't understand or ones with discriminatory shareholder structures. Working from these precepts, stocks become almost self-selecting (provided we have done the essential investigative work). The more difficult decision is how much to pay. Here we place little value in ephemeral events or market 'noise' and more on factors that will ensure we can add value in a demonstrable and consistent way over time. Our focus therefore is on long-term returns – capital growth together with dividend growth - rather than short-term gains.

What stocks have you bought recently?

We have recently added to our positions in AstraZeneca the global pharmaceutical company following the purchase of MedImmune a good fit in terms of focus (oncology, respiratory and cardiovascular) and product development cycle with the potential to generate some significant synergies. We have also increased the weighting in Venture Production a North Sea based oil E&P company with a low risk business model and the ability to benefit from fields that are too small for the oil majors. We think both companies have been oversold and that valuations are attractive on a long term basis (Astra 12x 2008 and Venture 10x 2008 P/E).

How do you decide when to sell a stock?

Normally it's a case of valuation, and as we are long term investors our approach is to top-slice holdings on price strength and top-up on any price weakness. Quality is the key criteria for initial investment so if we find reason to believe that this has changed we will also sell the holding. Interestingly, more recently, given the level of corporate activity we've also had to exit companies that have been taken over which has increased our turnover.

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