As prices begin to reflect this quality, however, investors would do well to trim their holdings. Needless to say cash levels will increase as investment opportunities in rising markets are harder to come by. Value is regularly accompanied by some form of blemish – there is a reason why an asset is cheap – so there is a trade-off between price and business risk. Stock picking becomes ever more important, and it is this tension that should frame investment decisions. An example of this dynamic is Rio Tinto, where the share price is discounting very low returns into perpetuity. Its management is promoting a more disciplined approach to investment (although in the short term, there are capital expenditure requirements) and herein lies the opportunity. This is a cheap stock and should be considered an exercise in lower price risk compensating for higher business risk.
Share prices of companies such as Diageo, Dechra Pharmaceuticals, British American Tobacco and Unilever have been weak; however, yet again, this is price risk coming to the fore. Indeed, it is not necessarily a bad thing for some of the froth to come out of share prices. Keller Group, a pilings and foundations business, is a case in point. Shares in this company have almost quadrupled from their lows (they may even go higher). Had you held this stock, it would have rewarded you well, but a sell discipline is essential in any form of investing and once the profits are made, it is time to ‘fish’ in different waters.
From an economic and market perspective, further bouts of volatility are likely. Excitement is coming from concerted doses of quantitative easing, and there is the contradictory spectacle of equities selling-off on good economic data, lest the easy money drug is withdrawn. Furthermore, investors should bear in mind that the necessary steps have yet to be taken that would begin to deal with the many structural problems that will beset economies – long-term liabilities in the US such as Medicare, Medicaid, and social security obligations; mending the eurozone, if that is possible, and the shift towards private consumption in China.
Once more, there are risks and uncertainties in any world view; the trick is to try and balance those out in a portfolio that offers the potential for income growth and capital preservation.
Carl Stick is a fund manager of Rathbone Income Fund
Key points
■ Some companies are returning cash to shareholders in the form of capital returns.
