Where to find growth after the blitz on shares

After three years of falling stock markets, you'd be forgiven for having lost faith in equities. But over the long term, investing in stocks and shares is still a better option than holding your money in cash. And there may be light at the end of the tunnel: many experts are optimistic that there will be some growth in the stock market next year.

However, the recovery, when it starts, is likely to be slow. Framlington is one of the more bullish investment houses, predicting that by the end of 2003 the FTSE 100 will hit 5,000. But most of the industry is more cautious: Credit Suisse and Schroders predict a year-end figure of around 4,200, only slightly higher than at present.

This year, stock markets have been hit hard by the Enron and WorldCom accounting scandals. But many companies were overvalued in any case as markets climbed at an unsustainable rate during the late 1990s. The slump of the past couple of years has been a correction and there is now a feeling that shares are more fairly valued, producing good buying opportunities.

"Interest rates are at their lowest for 40 years, valuations for the UK and Europe are looking quite cheap, and many undervalued companies have good long-term growth prospects, especially in the biotech, telecoms and construction sectors," says Bob Yerbury, chief investment officer at Invesco Perpetual.

As far as investors are concerned, this means going for a good stock-picking fund. Edward Bonham Carter, joint chief executive of Jupiter Asset Management, predicts: "This will be a stock-picker's year, with plenty of scope for genuinely actively managed funds to outperform the market."

Sales of unit and investment trusts have been low this year but many of those confident enough to invest have opted for equity income funds, such as Invesco Perpetual Income and Credit Suisse Income, and for corporate bond funds. Independent financial advisers (IFAs) think they will be popular again next year.

The UK is also a good investment bet because it has one of the strongest economies. "Consumers will remain supported by low employment, low interest rates and real wage growth," says Stephen Whittaker, manager of New Star UK Growth Fund. "The UK remains a cheaper market than the US and its economic fundamentals are also in firmer shape than the rest of Europe."

But diversification is key when investing. "If you're already in UK equities, you may be better off looking at a global fund rather than putting more money into the UK," says Anna Bowes, savings and investment manager at IFA Chase de Vere.

And if you've got investments that have consistently underperformed, it may be worth cutting your losses. "If a fund's been bad for some time and its performance is poor against other funds in its peer group, it's probably best to take the axe to it and buy into a replacement fund at a fairly low cost," says Michael Owen, director of IFA Plan Invest.

While acknowledging that equities look attractive in relation to bonds and cash, Peter Warnes, co-manager of Fleming Overseas investment trust, says investors should proceed with caution. "We expect markets to remain volatile," he says. "Regular saving, rather than trying to pick market peaks and troughs, will be a sensible strategy."

Although the outlook for growth in the markets is improving slightly, investors shouldn't expect to see the double-digit returns of the 1990s making a comeback. Between 5 and 7 per cent is a more realistic estimate, but with inflation and interest rates much lower than in the past, real returns will still be good.