Mark Dampier: Diversify to counter sovereign debt risks

The Analyst

Media attention has been fixated on the Murdoch empire recently with the sovereign debt problems in Europe seeing comparatively little coverage. However, events on the continent are of the utmost importance both economically and politically. It all started, of course, with Greece, a relatively insignificant constituent of European GDP at less than 2 per cent. The markets had dismissed a Greek default as a minor event so long as it was contained, but last week Italy suddenly became the focus of concerns and the crisis threatened to spread. As the third largest bond market in the world Italy is a whole different ballgame and not something that can be dismissed so easily.

I suspect this will rumble on for quite some time. European politicians seem reluctant to make the tough decisions to solve the crisis once and for all. The problem for investors is that predicting the outcome is doubly difficult when politics is involved, so what is the best thing to do? You could make the decision to retreat into cash, but remember you have two decisions to make here: the decision to exit the markets, and eventually the decision to reinvest. Get the timing of these wrong and you end up being no better off, and if the market suddenly rallies while you are on the sidelines you can miss out.

So what is the alternative? I have always been an advocate of having plenty of cash ready to deploy when markets fall, but it is also worth diversifying a portfolio by using different fund managers to help control the level of risk. Fortunately there are a good number of more cautious funds to choose from, and one that undeservedly gets little attention is CF Miton Strategic Portfolio. Martin Gray has managed the fund since December 1996, so he has seen his fair share of market ups and downs.

Unlike certain other funds that use complicated derivatives Mr Gray keeps things simple with an actively managed combination of equities, funds, cash, bonds, and foreign currencies. Presently he has around 40 per cent in a mix of UK assets comprising property, high-yielding shares, cash and gilts. Twenty per cent is allocated to the US through a mixture of equities, gold and cash, and 20 per cent to Japanese yen-denominated assets, both cash and equities. Finally, there is around 20 per cent in Asia, which is primarily in bonds.

Mr Gray has been bearish for some time, although he has successfully caught some of the rallies when he felt markets were oversold. I agree with him this is not a normal economic recovery. With unemployment staying stubbornly high in the UK and the US he has maintained his cautious stance and finds present equity valuations far from compelling. Nonetheless he is poised to take on more risk when he sees the right opportunities. His approach is to be patient and build up his equity exposure if and when markets fall, and with over a third of the fund in cash of various currencies he certainly has the necessary ammunition. Martin Gray does however draw some positives from his view of the world. Firstly, he believes inflation is not a serious threat. With demand easing he expects it to fall back unless we see further quantitative easing. Secondly, he believes interest rates are set to remain low with significant moves perhaps not until 2013. In this environment he believes bonds will do well, and he has already taken advantage of dips in gilt prices to add to his holdings here – in contrast to a number of high-profile bond managers who have shorted gilts and lost money.

This is not going to be a fund that sets the world alight in a bull market. Mr Gray is aiming to preserve capital and reduce volatility as well as provide upside. Sadly many investors ignore this type of fund when the times are good, forgetting that investment is a long-term game. Yet with Martin Gray's contrarian approach long-term returns have been commendable, so it is worth considering as a complement to more aggressive funds, or as a larger holding if you share the manager's views of the world.

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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