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Multi-manager View

It has been a remarkable start to the year. Markets are behaving as though there is little to worry about. The rally has been driven by the €489bn liquidity offered by the European Central Bank, the LTRO facility, to European banks, mitigating the risk of a fresh round of bank defaults. The LTRO, launched in December, led to a scramble to buy risk, whether in equities, credit or commodities. More financial support for Greece also helped.

The second phase of LTRO, at the end of February, should provide a further boost but much of this will be in the price. Sustainability depends on the eurozone economy, which is expected to shrink in 2012. The LTRO has not so far resulted in an increase in bank lending, which would provide a stimulus.

The eurozone budget rules impose a 3 per cent maximum deficit so governments cannot spend their way to growth. There is little faith that Greece, even if it achieves its target of 120 per cent of debt to GDP, is able to support such a burden or that the population is willing to do so.

Markets are not convinced. The correlation between German government bonds (bunds) and the Stoxx 600 index is at an extreme positive, with prices moving together, as pointed out by BoA Merrill Lynch in a recent report. If the markets expected economic recovery, bunds would be falling as interest rates would be expected to rise.

The LTRO has bought time for central banks and financial institutions to complete their contingency planning for a euro break-up. European banks will have had more time to strengthen their balance sheets and are able to resist shocks better. It leaves the option for Greece and others to leave the euro without causing a seismic shock.

Traditional multi-manager investing, where almost all the risk is in equities, has a problem. If you have been risk-on this year, you have done well. If not, you are behind the competition and need to hope your next bet will be right.

Fortunately, alternative investment approaches used by multi-manager funds offer diversification. One such strategy, which has in the past also offered protection against big market moves, is systematic trend following, which invests in equity, bond, currency and commodity markets. Managers develop computer models to profit from price trends and reversals lasting seconds to weeks.

The models are often independent and have a diversifying effect. Strict risk controls aim to optimise risk and return so that when there are big trends in several markets at the same time, such as in 2008, the models can profit. Even shorter-term or more mixed trends, such as in 2011, can be profitable, although less so.

I do not want to bet investor money with a crystal ball. If I construct a portfolio of different strategies and get the managers right, diversification should give me steadier returns over the long run, with less volatility than just betting on the direction of equity markets.

Michiel Timmerman is chief investment officer at Ignis Advisers

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