Low growth environment offers plenty of opportunities

Companies that generate solid underlying organic growth will offer some of the best opportunities for investors as the UK domestic growth environment remains muted in the immediate future, says Sanjeev Shah, Manager of Fidelity International's Special Situations Fund.

Shah says: "I think stocks that offer unrecognised growth will do well in this environment and I have started putting more of the fund into those types of companies.

"Earnings have been beating expectations but much of this has been driven by fairly aggressive cost cutting and we will increasingly need to see volume growth to drive earnings further.  Valuations, however, remain reasonable, still toward the lower end of their historical ranges on both price-to-book and free cash flow measures.

"I expect mergers and acquisitions (M&A) to become more frequent in 2010.  The conditions are there for activity to pick up as companies look to acquire growth in a low-growth environment. I think management teams that are keen to create shareholder value will increasingly consider M&A strategies."

Shah says, while the most opportune time for buying may have passed, there are plenty of reasons to be positive about equities.

He says: "We entered early 2009 with most people thinking we were going into the next Great Depression. As an equity investor, that was best time to find the sort of opportunities that I am looking for.

"I think we have moved more towards the hopeful phase of investor sentiment, however, we are a long way away from the more optimistic levels we usually see at the top of equity markets. I am still positive on equity markets in 2010. I do think we may see some sort of correction, some sort of consolidation, but in my mind that will be a buying opportunity for investors."

Shah has a contrarian investment approach that focuses on stocks whose value has not been fully recognised by the broader market.  Sectors that he currently favours include:

Media - the media sector has fallen out of favour in recent years as it has struggled with declining advertising revenues. However, Shah sees untapped value in the sector and holds some of the strongest franchises such as WPP, BSkyB and Pearson. He says: "These stocks are increasingly benefiting from structural growth drivers, such as the shift to online, yet are close to their historic lows in terms of valuations."

Technology - Offering organic growth in a low economic growth environment, technology stocks are offering good opportunities:  "The free cash flow yields on many stocks look attractive compared to longer-term history.  Logica is a good example of an unloved stock that has done well for the portfolio.  The company has undertaken a major restructuring under new management that is delivering cost savings and building order momentum.

Real Estate - Shah continues to favour real estate stocks and is overweight British Land and Land Securities: "The yield credentials of property continue to be overlooked by investors in what is a very low yield environment.  The average duration of Land Securities commercial tenants' leases is around 13 years, usually with upward-only rent revisions. Assuming these tenants do not default, and they shouldn't as they are generally high quality, the rental yield exceeds the cost of financing and they have a locked-in income stream for a significant length of time."

Shah continues to remain underweight commodities which he believes are expensive on a fundamental basis.  He says: "I am more cautious than the market on the supply and demand environment for a lot of industrial metals."