Large-caps to offer best prospects as challenging markets persist

Since Hak Salih took over management of the Santander Equity Income Unit Trust in June 2007, he has delivered upper second quartile performance.

The fund has also just delivered a calendar year distribution that is 58% higher than 5 years ago, a compound growth rate of 9.6%, highlighting the case for being invested in income yielding equities over the long term.

Hak comments on the prospects for the market and the changes he has made to the fund: "We stated earlier this year that we believed the weaker outlook for the UK economy would produce a sustained period of Sterling weakness. Following weakness against the Euro this has now been joined in the past few weeks, by a significant depreciation of Sterling against the dollar.

"Against this background, I continue to favour larger caps in the UK, especially the mega caps with significant exposure to dollar markets. These continue to look attractive, with strong balance sheets, stable earnings prospects and growing dividends at attractive initial yields.

"We therefore remain overweight in pharmaceuticals, which continue to offer attractive yields at good valuations, and whose earnings will benefit from sterling weakness. We believe that uncertainty on growth constraints, patent expiries, drug pipelines and the US election have already been discounted in prices.

"For valuation reasons we retain a large position in the oil majors, whose dollar dividends will now also benefit from the strengthening dollar. For example, BP, on consensus dollar estimates, will be yielding over 6% next year. Price performance has been less oil sensitive than many analysts believed, with both BP and Shell holding firm in the face of falling oil prices. In early July we built a position in British Airways, attractive on its own merits and useful as a hedge against any fall in the oil price.

"We have materially shifted our view on domestic banks in response to changing valuations and last month bought into Barclays, Lloyds and RBS in advance of the bank reporting season. The shares had become very oversold, with several banks trading below book value.

"Margins on new lending have increased significantly in recent months, and evidence of attractive valuations in the sector is supported by Banco Santander's bid for A&L at a time of diminished investor interest.

"We also selectively bought into house builders where share prices have fallen considerably, and trade at substantial discounts to asset value even after you write down the land banks for our expectation of sharp falls in land prices. In a few months we will get to a position where the annualised falls in volumes will flatten out - its difficult to see volumes next spring down 40% year on year when they are already down around 40% this spring.

"Our overweight position in telecommunications has yet to be reflected in share performance, and the sector continues to under perform the market. Contagion from disappointing results on the continent has impacted sentiment on UK telecoms, but I maintain our long-term view that the sector remains attractively valued and we are overweight in both mobile (Vodafone) and fixed (British Telecom) segments.

"We remain underweight in mining against the market since we believe that the sector has become overvalued. However, I have positioned the fund to take advantage of special situations arising from corporate activity, through investing in Anglo American and Lonmin, which we are pleased to see, is now subject to a bid from Xstrata.

"Looking forward, although the fund has delivered excellent distribution growth over the last five years, the economic environment looks increasingly challenging, with the Bank of England predicting zero growth at the start of 2009. However we aim to continue to deliver distribution growth at a rate higher than inflation.

"Domestically exposed small and mid caps will continue to under perform due to pressure on consumer incomes. This will, in time, create value situations, which we can capitalise on by buying quality companies at very good prices.

"In the meantime we continue to favour large-cap stocks offering international exposure, attractive valuations and strong yields."