The expected tapering of monetary easing in the US and beyond has already resulted in rising yields across the fixed interest market. Historically, such an environment has unsettled equity markets in the short-term and has prompted some fund managers to cut back their risk exposure in recent months. Walker (pictured) acknowledges that there could be near-term turbulence – particularly because markets have performed strongly in the last three years or so – but thinks all-out panic is misplaced, given that the end of QE is a direct result of improving economic growth.
"An improving outlook for economic growth, notably in the US, has led to concerns over an imminent end to the monetary easing and to bond yields rising in anticipation of a hike in interest rates," said Walker, who heads up the Invesco Perpetual UK Aggressive portfolio.
"The resultant increase in the risk-free rate of return, and thereby the cost of equity, has been putting pressure on equity valuations. However, looking further out, I believe that equities own a 'call option' on future economic growth."
Performance of indices over 3yrs
Source: FE Analytics
"Once expectations of rising bond yields have levelled out, I expect equities to continue their upward path."
It has been an unusual time for equity markets of late, with positive economic news often resulting in weak performance – and in some cases vice-versa.
However, Walker says it is important to look past the short-term noise and focus on fundamentals, which drive longer-term returns.
"It is worth remembering that economic growth is one of the drivers of equity performance, which is not the case for bonds," the manager explained.
"Economic growth underpins growth in company earnings and hence the improving economic outlook should prove positive for equity markets over the medium- and longer-term."
"It is also worth noting that the end game of quantitative easing is not deflation but inflation – and that equities, with share prices driven by nominal earnings growth, are a much better bet than bonds in an inflationary environment."
Walker says there are three pillars to stock market returns – starting valuation, company earnings growth and investment of retained earnings.
"After such a strong run over the past few years, combined with the recent rise in the risk-free rate of return, equity markets are no longer as compellingly good value. But the latter two pillars are still very much in place, particularly in an improving macro-economic environment," he said.
"In terms of constructing a portfolio to perform in this environment, the key, I believe, is that you need exposure to growth, which will mitigate against a rising risk-free rate of return. This growth exposure can come in several guises, including a correlation of earnings to economic growth and by under-appreciated self-help stories."
With this in mind, he identifies three stocks that are set for growth for very different reasons.
WPP
"This is one example of a company I hold in the Invesco Perpetual UK Growth fund and where I see very clear exposure to economic growth," said Walker.
"As one of the world's largest creative and marketing services groups, with operations in over 100 countries, WPP is strongly placed to benefit from an improving global economic outlook."
The FTSE 100 media company has had a very strong run recently, delivering more than 100 per cent over a three-year period. This compares with 37.53 per cent from the wider index.
Performance of stock and index over 3yrs
Source: FE Analytics
Walker has a major position in WPP in his Invesco Perpetual UK Aggressive fund, but it is not a top-10 holding. It is, however, for 25 funds in the IMA unit trust and OEIC universe, including Fidelity Moneybuilder Growth and Investec UK Alpha.
Resolution
FTSE 100 insurance outfit Resolution is Walker’s fifth-largest holding, with a 4.8 per cent weighting in Invesco Perpetual UK Aggressive.
"Our holding is predicated on growth, which is very much more company specific," he said.
"The provision of defined contribution pension schemes and annuities is not typically viewed as a business to get the pulse racing, but the demise of the company-provided defined benefit scheme and an ageing and wealthier population have combined to make investors see this sector in an altogether different light."
"Looking forward, defined contribution pensions are likely to provide the major part of people’s retirement plans."
The improving sentiment surrounding the sector has helped Resolution post more than 60 per cent in the last 12 months alone.
Invesco Perpetual UK Aggressive is one of three funds that hold Resolution in their top-10.
Topps Tiles
Finally, Walker points to FTSE Small Cap constituent Topps Tiles as a good growth play. It is also a favourite with FE Alpha Manager Paul Spencer, who holds it in the top-10 of his Franklin UK Smaller Companies fund.
"A different type of growth exposure can be found in Topps Tiles," said Walker.
"The UK’s largest tile specialist is set to benefit from the uptick in the housing market, with a further boost expected from the UK government’s recent housing-related measures, as well as from its own investments as part of its strategy to grow market share."
Performance of stock vs index over 6yrs
Source: FE Analytics
Like most companies associated with the housing markets, Topps Tiles had a disastrous 2007 and 2008; however, it has recovered strongly since then, posting particularly good gains in 2012 and so far in 2013.
Walker took over as lead manager of the Invesco Perpetual UK Aggressive fund at the beginning of this year, but has headed up the UK Growth portfolio for just over five years.
Performance of manager vs peers over 10yrs
Source: FE Analytics
The manager has consistently outperformed his peer group composite over the last decade, with cumulative returns of almost 200 per cent over the period.
