Oil exploration and production company Cove Energy has put itself up for sale.  Its Africa based assets include the 8.5% stake in the Rovuma Area 1 offshore Mozambique. The partners have discovered 15-30+ trillion cubic feet (“TCF”) of gas already with plenty more prospects to drill in what is shaping up to be a very significant liquid natural gas project.

This move is likely to see interest from both oil majors looking to add new resources and Asian utility companies seeking security of supply of gas.

Cove Energy is held in both the F&C UK Equity Income and F&C UK Alpha Funds, so both have done well from their holdings and are set to benefit from any further rise in the Cove share price now that the announcement has been made.

This is just the result we look for from companies in the E&P sector and is in line with Cove’s stated strategy since the Funds bought into the stock some time ago.  We have worked closely with the company and helped fund their exploration activities through a series of equity fund raisings.  This was on the clear understanding that there would come a point when they would look to realise the value of the assets they had discovered, leaving it to the larger players with deeper pockets to fund the final development and production phase of their assets.

Equity markets are clearly being driven by macro factors and this looks set to continue for some time to come.  So looking for capital growth potential through bottom-up fundamental analysis has been difficult.

In such an environment though, bottom-up research still has a lot of value in identifying strong sources of income potential for my UK Equity Income Fund.

I have been looking at the listed Lloyds syndicates and recently added Amlin to and increased holdings in Beazley in the portfolio.  The outlook for insurance rates is positive and both organisations have a conservative approach to investment in the business.

Both companies also have an attractive dividend yield around 7%  for Amlin and 6% for Beazley, which I believe should be sustainable.

London Mining with its iron ore assets in Sierra Leone is a favourite of both Peter Lees and myself and held in our UK Alpha and UK Equity Income Funds.  We both own the equity and I also own the convertibles in the income fund aiming for the best of both worlds.

Having visited the London Mining operations in Sierra Leone a few months ago I was keen to attend last week’s seminar on investing in the country hosted by the High Commissioner to the UK and the Ministers of Finance and Economic Development, and Trade and Industry.  Henry Bellingham MP, the Africa Minister in the Foreign and Commonwealth Office was also there. 

As an existing investor in London Mining I wanted to hear what was said about foreign investment into the country, as their overall approach in this area would likely impact on the value of my holding.

The news was very positive with the government making clear its intention to promote foreign investment in three key areas, agriculture, tourism and mining.

What was also reassuring to hear was the progress the country is making in terms of transparency and corporate governance.  In a recent World Bank Report* Sierra Leone was identified as one of the most improved areas for doing business as a result of economic reforms put in place across the country now that the civil war is over.

Iron ore is the key asset for London Mining and the development of this resource is also crucial to the GDP and health of the domestic economy.  The start of production from two iron ore projects (including London Mining’s Marampa asset) in December 2011 will likely see the country’s GDP increase from $2.1bn to $3.4bn, over 60% in 2012.  If only George Osborne could engineer such growth all our debt problems would be over!

* World Bank – Doing Business 2010 - Doing Business in a More Transparent World

Why is a manager of UK equities off on a fact finding trip to China I hear you say.  But as you know, the UK equity market is much more a play on the global economy than the fortunes of the UK, so it’s eminently sensible.

There area number of issues I will be focusing on in my meetings.

1. To find out what it’s really like on the ground rather than just believe what commentators tell us.
2. What are the supply chains like and how could they impact on economic activity elsewhere.  Remembering the impact of the de-stocking back in 2008/09.
3. How is the funding of industry and infrastructure segregated from that of the property sector?  Can the impact of any property bubble bursting be ring-fenced?
4. I am also attending a meeting involving the big mining companies and China’s state planners responsible for infrastructure investment. I will be looking to find out if the mining bosses are right in that the scale of the internal investment is still such that any moderation in global growth will not really be an issue for them.

So watch this space as I will be reporting back in a conference call on 20 October at 11.00 am.

I’ve just come back from visiting a company that both Peter Lees and I own in our UK Alpha and UK Equity Income Funds.  The visit involved a very early start as I joined the regular commute to work of some 20 specialist workers.

Though I must say I felt somewhat disconcerted as I pulled on my special dry ‘ditching suit’ and listened intently to a 30-minute safety briefing before getting on a helicopter flight to an oil rig way out in the North Sea currently working for Hurricane Exploration.

An absolutely fascinating trip though, watching the extremes of drilling with a 2.5 kilometre pipe hanging from the rig, housing hugely powerful drill bits and ultra-sensitive electronic measuring equipment.  All in all a very successful and highly educational trip.

Hurricane is a private company that is looking to float in the near future. The breadth and depth of the team’s contacts across the market means we are quite often offered the chance to invest in private companies ahead of their intended flotation on the market.

The current size of our two Funds means we can both get meaningful exposure to a small number of these exiting opportunities - something just not possible for much larger funds.

I must say though, I now look at the train in an entirely new light – even when it’s late.

The results season is in full swing and most companies are largely in line with expectations.  However, we are beginning to see some modest downgrades to expectations for 2012, but that is largely to be expected at this stage of the cycle.

The downgrades are being driven by a squeeze on margins from increased costs and investment, though the latter should in most cases be regarded as a long-term positive.  We currently see no reason to change to our growth expectations, but feel that the market may be expecting a bit too much at the moment.

That said, as an income manger, strong corporate results means I am bullish on the outlook for dividends.

Looking beyond the US’s budgetary issues, which I expect to go right to wire and possible a little beyond before resolution, I have begun to build a holding in Schroders.  I feel that once the current headwinds abate the market will be in a much better position and Schroders is a potential beneficiary from a broad market rise.

I’ve sold Northumbrian Water now that the bid is in place as it’s effectively ‘dead money’ and can be better used elsewhere. We are not expecting a counter bid.

The summer traditionally brings lower volumes and higher volatility. This year though this is likely to be exaggerated by the on-going European sovereign debt crisis and the ‘risk-on’ ‘risk-off’ trading patterns.  But with volatility comes opportunity.

The other big plus for the market at the moment is valuation. At the current stage in the recovery cycle the market’s price earnings ratio should be around 14x but it is actually only at some 10.5x.  This means there is the potential from earnings multiple expansion in addition to economic growth, once we have a bit more clarity on the macro environment.

I mentioned previously that Cheung Kong Infrastructure was considering a bid for Northumbrian Water and this has duly arrived.  The figure of 465p per share, plus the final dividend of 9.5p, represents a fair price and locks in a strong profit for the Fund, where average price paid for our holding was around 300p.

Australian Prime Minister Julia Gillard’s announcement of a new carbon tax on the resources sector, which will land heaviest on the coal producers, while disappointing was not really too much of a surprise. She is following a clear theme of governments looking to raise funds from the resources sector – UK, Chile and Tanzania – and I am sure she won’t be the last.

Rio Tinto is a significant coal producer and my biggest mining position in the Fund, though I also have positions in Xstrata and BHP Billiton.  All three will be modestly impacted, though the reality is that the current strong demand globally for resources shows little sign of slowing in any material way, so the impact on profitability should be limited.

The announcement that Cheung Kong Infrastructure are considering a bid for Northumbrian Water has breathed new life into the utilities sector and provided a boost to my F&C UK Equity Income Fund.  This announcement was quickly followed by engineering group Melrose approaching Charter with a view to an acquisition and while I only hold a very small position in Melrose, Peter Lees does have a significant position in his F&C UK Alpha Fund.

The important point here though is that it indicates that M&A activity remains in rude health and there are two main reasons why I believe this will continue. 

The first is the strength of company balance sheets and the need to put capital to work or return it to shareholders in a low interest rate environment. The second is that with growth starting to wane in certain areas margins are beginning to come under pressure, which seems to be the case with Charter deal.  Any corporate activity that enables costs to be taken out of a combined business is likely to be attractive to shareholders.

While potential M&A activity is not a key driver of investment decision making within my Fund, it is something we need to be aware of when conducting our analysis.

Expectations push shares too low…
With the UK economy in the doldrums many investors have focused their attention on UK companies with a high proportion of international sales.  The F&C UK Mid-Cap Fund has benefitted over the last two years from a significant exposure to developing economies particularly in the Far East.  Building such a position was the result not only of a view on Asian growth but the conclusion that the strong growth not factored into share prices.

More recently I find that the share prices of UK companies with a high proportion of domestic sales factor in a very low level of expectations.  In fact many share prices imply a slow perpetual decline.  So whilst I too see the weak economic data and tough outlook for the UK, there has been increasing opportunity for stock pickers to find a clutch of “diamonds in the rough”.

…providing opportunities for selective investors
This focus has paid real dividends with a number of our holdings impressively delivering the goods thus far in 2011.  With expectations low any sign of stabilisation – let alone good news - is greeted warmly by investors and can result in a meaningful uplift in the share price. 

One theme is the emerging market wealth that is spilling over into the UK economy via the London property market.  Whilst the overall UK housing market remains fragile, demand in London has been robust.  The London focused Berkeley Homes has just announced sales reservations 30% higher than last year and a plan to return a significant of cash to shareholders.  West end property specialist Shaftesbury recently reported that “visitor numbers and spending have remained buoyant” and their property continues to “experience healthy demand” whilst “vacant space remains at a historically low level”.

With the overall economy struggling, much has been made of the UK government outsourcing opportunity.  The key here has been to find those businesses with the skill sets that are in short supply and that can deliver savings for the public sector.  The Ministry of Defence in particular needs to find ways to save costs whilst maintaining its operational capability.  Defence engineering company Babcock is in the right place reporting a bid pipeline up from £5bn last November to £6bn in January and £8.5bn now.

Homeserve is a company that derives the overwhelming bulk of its profit by selling plumbing and drainage and electrical insurance to UK households.  The market had been concerned that a weak consumer would stop renewing these policies.  In fact by developing innovative new products and utilising a well incentivised sales force, Homeserve saw 10% growth from is UK business in the year to March 2011.

We have been selectively and carefully increasing our exposure to domestically orientated investments throughout 2011 with a corresponding reduction in our overweight towards the industrials. 

F&C UK Mid-Cap Fund is placed in the top decile of the IMA UK All Companies sector over 1, 2, 3, 4, 5 years and since launch.* 

*Source: Lipper Hindsight to 31 May 2011.  Launch date 31 December 2005.