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UK: Pausing for a breather

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The UK market is due for a pause for breath" says Bob Morris, fund manager at Lucas Investment Management. While the general election is undoubtedly significant, in the long term the outcome will not have a large impact in the market. He ex-pects interest rates to rise soon after the election and believes that if inflation pressures build through the year "it will be difficult to see the UK equity market progressing that greatly".

Longer-term prospects for equities are slightly more positive. If the government hits its inflation forecast this year Morris feels "there's no reason why it can't make moderate progress". One possible result of the election, taxes being levied on pension funds' dividend income, will have a major, if only short term, impact on equity evaluations. And he is unsure how much the market "has fully appreciated the extent of windfall taxes in the utilities sector". His forecast for re-turns on equities in the long term is "about 8%", while his opinion on bonds is cautious, sensing they will "struggle to make progress".

"Whilst we don't view the UK in a particularly bad light, there could be quite a big shake-out because I don't think risk is necessarily being priced in properly around the world." This is more a global phenomenon than a UK one, and he still takes a fairly positive stand on long-term fixed income, predicting they will "marginally push upwards" to about 8.5%.

The stocks to buy in 1997, thinks Morris, are those "re-lated to domestic investment spend", the construction sectors which he says will benefit over the next 12 months, particularly in the event of a Labour victory.

The Lucas Pensions Trust is worth an impressive £3bn. Heavily equity-biased, it is split 60% UK, 20% developed overseas and 10% emerging markets equities. Just 10% is non-equity, divided equally between bonds and index-linked funds.

"Historically the fund has been very heavily weighted in equities," says Morris. Up until recently, it was predominantly UK equities. An asset/liability study carried out at the end of 1995 concluded that Lucas would get better returns in the long term on equities than on fixed interest securities, given the company's funding position. Lucas was "happy taking on the extra risk," says Morris. However, the company de-cided the portfolio was better spread across markets to reduce risk

The UK and developed markets equities and fixed in-terest and index-linked sections of the portfolio are all managed in-house. The only external managers Lucas em-ploys are for its emerging markets investments, largely because Lucas felt that no one in-house had the right expertise. Two thirds of the £300m portfolio is passively managed by Barclays Global Investors, while the remainder is actively managed by Genesis Investment Management. Two thirds of the UK equities are passively managed, as are all developed overseas equity investments, which are in index-tracking funds. Lucas is not planning to increase the amount of actively managed funds, which stand at 20% of the total fund. The £600m of actively managed funds is invested in 30-40 stocks, on a "bottom-up basis," says Morris, adding quickly that this is not strictly true "as we do pay a lot of attention to the asset allocation, so the stocks we choose tend to fit into our top-down view on life." Rachel Oliver"

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