Mark Dampier: A good insurance policy for times such as these
Saturday 09 June 2012
Facebook's initial valuation seemed expensive to many investors. The $104bn (£66.78bn) the company was worth when it floated last month meant each of its 900 million active users was valued at nearly $120 of annual advertising revenue each.
However, this is nothing compared to the extent to which the sovereign bond markets of the UK, US, Germany and Japan are overvalued, according to Stewart Cowley, manager of the Old Mutual Global Strategic Bond fund.
It is somewhat different to other bond funds. Mr Cowley manages it with capital preservation at the forefront of his mind.
That is not to say he doesn't want to make money, but there are times when capital preservation is important. The current economic environment is just such a time.
This does means that it is not a fund for investors seeking a high income. It currently yields around 1.5 per cent.
While Mr Cowley believes sovereign bonds are absurdly overvalued he is loath to bet against them without a hedge in place. This is because he believes the market is effectively rigged. Governments are buying their own bonds and panicked investors are fleeing the banking systems of southern Mediterranean countries. He therefore holds US treasuries and UK gilts whilst simultaneously shorting German bunds.
If German bunds underperform their UK and US equivalents the trade will create a positive return for the fund; if they outperform the return will be negative. This in itself generates modest returns, yet if German bunds weaken significantly, the trade could be highly profitable assuming UK and US bonds do not fall by the same degree.
As for European monetary union, Mr Cowley believes it is reaching an end game. New rules on maximum deficits and the amount of debt countries can have as a percentage of GDP are being drawn up. Nations are losing their discretion to act – they will have to comply or leave the union.
At present, 85 per cent of the fund is exposed to sterling, though he regrets not having held more in US dollars. The fund can invest up to 100 per cent in overseas currencies, but while he thinks sterling will have a crisis he thinks it is a year or so away yet.
The outlook for corporate bonds is more positive. Mr Cowley is comfortable companies generally have plenty of cash on their balance sheets, while yields offer sufficient compensation for the risks. He believes the Bank of England will continue to underestimate inflation so it doesn't have to raise interest rates. He points to urbanisation and increasing wealth in emerging nations as likely to have inflationary effects. Many investors seem to be ignoring the potential for stubbornly high inflation, but he has built protection into the portfolio via index-linked gilts.
In this environment, you want a fund that does everything possible to protect capital while having the potential to capture the upside when the time is right.
In my view, this fund looks like a good insurance policy.
Mark Dampier is head of research at Hargreaves Lansdown, the asset manager, financial adviser and stockbroker. For more details about the funds included in this column, visit www.h.l.co.uk/independent
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