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Where, not what

The Miton approach that generated positive returns in our balanced managed funds in 2008 is the unconstrained management of asset allocation. We believe fervently it is where one invests, rather than what one buys that determines the absolute return of a fund.

There were rather more obvious asset allocation themes that could be exploited with confidence in 2008 – global economic slowdown, sterling weakening, equity markets falling, commodity prices falling – but 2009 is not proving so easy.

It seems the big moves in currency markets have happened, leaving us only with volatility. Low interest rates and the lack of obvious opportunities in currency markets have reduced the role of cash exposure in the funds from a source of strong gains in 2008, to merely smoothing volatility and limiting downside risk.

The continued weakness in the global economy may be fully priced into equity markets but although the pace of the slowdown has slackened, house prices in most major economies are still falling and unemployment is still rising, so the consumer-led recovery necessary to provide some relief to the global economy feels like a distant and optimistic hope rather than a near-term probability.

In this environment, it is difficult to see how corporate earnings can improve significantly to sustain the recent rally in equity prices.

Commodity prices may have overshot on the downside presenting a buying opportunity, but a thought that keeps nagging is it is rarely the case that the sectors that led the previous bull market, lead the next one. Strong commodity markets are associated with periods of strong economic growth and high demand – a very different backdrop to the present situation.

It is ironic that the number of technology funds has fallen to a mere handful of survivors and it is being mooted that the Investment Management Association’s technology and telecommunications sector may be scrapped. The sector now appears to offer some real attraction, nine years after the bust in 2000.

The need for companies to cut costs and improve efficiencies in these straitened times is just one reason why technology stocks have been prospering recently.

As contrarians, we tend to shy away from “the buying opportunity of a lifetime” stories such as we are seeing in the corporate bond sector. Is this really such a one-way bet? It is not hard for us to believe that the level of corporate failures implied by yields will be reached, with a correspondingly high level of debt default.

Nor is it inconceivable that the economic slowdown will last longer and be deeper than most people are hoping so that the spread of corporate bonds yields over gilt yields is entirely justified. The implied level of risk in owning corporate debt rises as yields rise and this is happening at a time when institutions are increasingly averse to risk. Their non-participation creates a liquidity problem in the market, leading to increased volatility.2009 is proving a difficult year in which to find clear investment trends but an unconstrained approach to asset allocation provides the flexibility to take significant positions where opportunities lie while managing downside risk.

Sam Liddle is manager of the CF Miton Global Portfolio

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