Friday, July 9, 2010

Focus on re-regulation is prompting risk aversion

Focus on re-regulation is prompting risk aversion
Tom Digenan
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Volatility has returned to markets, driven by events within the US and from abroad.
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The heightened focus on re-regulating the financial system has prompted many investors to become more risk averse. This, in addition to sovereign debt issues in Greece and other eurozone countries and the Gulf of Mexico oil crisis, has put tremendous pressure on the US equity market, with the decline from the high points reached in April now exceeding 10%.

Focus on re-regulation is prompting risk aversion

Our portfolios are well positioned for a market being driven by fundamentals. However, the main drivers appear to be macro concerns and risk aversion. This environment has proved challenging and difficult for value investors, but we remain confident this will be for the short term. We remain convinced our price/intrinsic model will continue to deliver outperformance for clients over the long term in varied market conditions.

On a stock-specific standpoint, some of the main detractors from short-term performance are those where we still maintain a high degree of conviction. Examples include Covidien, Exelon and Baker Hughes, which was particularly affected by the expectation of stricter guidelines on offshore drilling, following the BP oil spill.

We are not only long only but also long/short investors.

On the short side of our portfolios, two of the largest detractors from performance have been Netflix and Akamai Technologies. Netflix’s principal activity is to provide an online movie rental service. While we believe Netflix will continue to increase cashflows through continued subscriber and revenue growth, we believe the current valuation implies greater growth potential than our own expectations. We also believe competitors, Time Warner and Comcast, have more efficient long-term delivery mechanisms for on-demand viewing. With Akamai, we expect increasing competition from Level3 Communications, Limelight Networks, Verisign and Google will limit the company’s growth potential.

On the long side, our positioning in utilities hurt performance. Exelon and First Energy both lagged the market during the downturn and modest recovery. However, the market is not providing sufficient credit to either company for the competitive advantage their nuclear capacity provides.

Tom Digenan is manager of the UBS US Equity and UBS US 130/30 Equity funds

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