Morgan, who manages the Aegon UK Smaller Companies fund, said she expects to see a bigger difference in earnings momentum between stocks over the final half of the year.
"Although domestic consumer and public sector stocks have de-rated somewhat in the first half of the year we expect there to be renewed weakness in relative performance in the second half as downgrades are crystallised by the year end budgeting process," she said.
Morgan (pictured right) said she continues to favour stocks which can deliver upgrades and expects those to be skewed towards international exposure, business spend and structural growth.
"Market valuations are attractive currently at around 10x next years earnings, which is low in a historical context, with no real premium being paid for smaller companies. Given the difficult pockets of the global economy strong stock selection will continue to be essential to outperformance," she explained.
Over a one and three year period the Aegon UK Smaller Companies fund has outperformed its peer group – the IMA UK Smaller Companies sector.
Performance over 3-yrs
Source: Financial Express Analytics
Morgan has also performed well, outperforming her peer group over a one and three year period.
Performance of Elaine Morgan vs peer group over 1-yr
Source: Financial Express Analytics
Morgan puts the performance of the fund down to a successful strategy which has been adopted since its launch in June 2006.
"The fund has been successful in selecting stocks which have benefited from the important economic themes over the years since launch," she explained.
Looking back over the last three years, Morgan said the areas which performed badly have been those which were too enthusiastic to take on the high debt leverage that was not afforded by debt market conditions before the credit crunch.
"The sectors have not only seen underlying trading weakness but they have had to recalibrate their debt leverage to lower levels. This was most marked in the real estate and construction related sectors," she said.
Morgan points out that the fund benefited from a broad underweight to these stocks in 2008 but then was able to earn some profits from the area through the recovery and refinancing phase in 2009. She said that exposure has subsequently been reduced.
Reflecting on areas that did well throughout the same period, Morgan said during this time few areas have delivered consistent outperformance.
"The only sector we would have been consistently overweight through the period would have been software. Software has been a strong deliverer of performance to the fund over the last three years due to elements of structural growth driven by product innovation but also due to the ongoing consolidation of best in class software companies," she said.
"The fund has benefited from this over the three years as holdings Axon and Detica have been bid for. Fidessa, Telecity and Craneware have also seen strong organic growth."
Going forward, Morgan said the fund is invested in many companies with high international exposure, particularly those with a high emerging markets percentage. She said this is a reflection on the concerns of a slower recovery in western economies going through austerity measures.
"The fund prefers companies with exposure to business operational spend and capital expenditure. While cash balances have been rebuilt and profits are in recovery, capital expenditure is still at a low point. Many companies we meet are signalling an increase in capital expenditure plans as they move back to normal investment levels from a cash preservation strategy," she said.
"In contrast the consumer spending cycle has already recovered and there are headwinds as public sector spending cuts are clarified.
"The fund continues to invest in structural growth – driven by regulations or technology adoption. Stock examples are Craneware - revenue assurance software for US hospitals - Abcam - internet distribution of antibodies for pharmaceutical research - and Telecity a datacentre company which benefits from a increase in demand for data over broadband," she concluded.