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Sovereign powers

Eight months after the credit crisis started to unfold, there is not much let-up in the newsflow from banks of writedowns leading to balancesheet rebuilding via rights issues and deals with sovereign wealth funds.

There has been much conjecture and concern over the prospect of SWF investment and potential influence on major banks. There is worry that they may use that influence for strategic national reasons, in ways that traditional investors would not. The reality is that SWFs provide the only opportunity for banks to patch up the holes that have appeared in balance sheets because of excessive risk taking in the years of easy credit.

There has been a huge transfer of foreign exchange reserves around the world, much of it ending up in newcomers’ hands, hence the birth of the SWF. Where countries had tended to manage overseas investments through the purchase of other governments’ bonds, SWFs are getting so big – and perhaps the opportunities so interesting – that they are prepared to take big equity stakes in strategically important businesses.

We are likely to see some changes in ownership in a number of these businesses, including banks. The scale of their problems is too big for their own governments to be sole providers of the bailout. Central banks have done well with their sticking plasters so far but there will be a limit to what they can do. SWFs will be a welcome source of cash.

With regard to our strategic and special situations portfolios, asset allocation has been focused towards defensive areas over the last six to 12 months but there have been some good investment opportunities if one has been prepared to look beyond the mainstream.

The unwinding of the carry trade has been a theme for both funds in the last six months, with holdings in JPM euro liquidity, Goldman Sachs yen reserve and Fidelity Swiss franc performing strongly in sterling and dollar terms. Both funds have had a high weighting in gold, with strategic holding BlackRock gold & general while special situations has had a focus on gold exploration shares. Taiwan has been a particular focus of the low equity portion of the portfolios, having performed extremely well on the back of recent election results. Sovereign global bond funds figure strongly, predominately managed in euros.

The credit crisis has still to unwind into the corporate and private sectors, so 2008 is likely to continue to produce volatile returns across most asset classes. “Sell on denial, buy on depression,” goes the old saying. We are still keeping some powder dry for the present.

Martin Gray manages the Miton strategic and special situations portfolios

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