Paralysed by fear of what may happen in the future? Tempted into over-trading by the noise of the markets? Worried that you hold too much cash and too many bonds? Feel that you should chase the tips you read in the media?
Join the club! You’re far from being alone – investing has become a rather neurotic business in 2010. In these volatile, uncertain markets, even adventurous investors can be paralysed by two seemingly contradictory forces. They know that there’s a lot more “bad stuff” (sovereign debt default and worse) to come – why else would anyone buy gold? – so they’re holding large amounts of cash and seemingly expensive AAA bonds. Yet they’re also tempted into chasing short-term trends – racing to buy into relief equity rallies, and busily shorting into slumps.
But one person I’ve spoken to lately who isn’t fazed by the fear and uncertainty is James Montier of fund management group GMO. He still believes that investors need to focus on building a balanced and focused portfolio.
According to Montier, you need to have a robust portfolio “that can weather multiple outcomes”. He cites London Business School’s professor Elroy Dimson’s definition of risk: “Risk means more things can happen than will happen”. For Montier, a cautious investor needs to think about those risks and then think: “OK, I don’t know whether it’s inflation or deflation. How do I deal with that? What assets can I find that could give me an interesting portfolio that will do well, or at least mean part of the portfolio will be doing well, under all those scenarios?”
Montier also believes that dealing with risk involves staying focused on “a kind of battle plan” based on equity valuations. He says: “This is probably the most sensible approach to long-term investing. Pre-commit that when you get down to X times on your chosen multiple, you will start to buy and, when it gets up to Y times, you start to sell.”
Surviving in these volatile markets also means focusing on dividends and their growth – as suggested by Merryn Somerset Webb in her column last week (FT Money, September 4/5, page 7). But Montier maintains you need lots of cash as well – he holds 40 per cent of his current portfolio in cash plus between 5 and 10 per cent in gold.
But this caution shouldn’t blind adventurous investors to opportunities, Montier says. “Deploy some cash into quality blue chip stocks, some into emerging markets, and some into international stocks, ie Europe,” he suggests. “The UK [market] does look kind of fair value, the US looks expensive, Europe actually kind of looks cheap. Not bargain basement ‘God, I can fill my boots with the stuff’ cheap. But on the cheap side of fair value.”
Montier is even enthusiastic about some emerging markets – he likes Asian “value” economies such as South Korea, alongside Turkey, plus a small dose of Russia. He’s moderately enthusiastic about China: “The aggregate stock market doesn’t look that expensive – the stuff within it you wouldn’t want to go near – but, as an aggregate, it doesn’t look hideously expensive”.
Moving back to the bigger picture, Montier doesn’t even seem that worried by the “50/50” chance of a double dip recession. “I’m worried that policy mistakes could well be a source of deflationary pressure, so the austerity plans do look like a really bad idea,” he says, However, he adds: “The good news is that if we do get a double dip, we are likely to see prices among equities fall … so people will then panic, equities will get cheap and then I can start to get greedy again!”
But there is one asset class that definitely doesn’t get the thumbs-up: bonds. According to Montier, bonds suck. “To me, the long-term outlook is still skewed towards inflationary risk and holding bonds in that environment doesn’t make sense. What we would be doing is buying Australian and New Zealand bonds because they are the one group of government bonds that kind of look fair value – Aussies are yielding over 5½ per cent.”