8th August 2011

Comment on European market activity from Close Asset Management

Chris Bailey, Head of UK & European Equities at Close Asset Management, comments on market activity in the last week:

It almost goes without saying that last week’s financial markets were extremely volatile; at the time of writing the FTSE100 index is down 9.8% and the S&P500 index is down by 7.2% (in US Dollar terms). UK bond markets, however, have been very strong with gilt prices rising over the last week as investors seek safety.

We believe there are three big unresolved macroeconomic issues in the world today –

• European deficit/debt issues;
• US fiscal challenges; (as reflected by the downgrade of US AAA debt rating over the weekend)
• Chinese growth profile.

In our opinion the above three issues are unlikely to be solved easily or immediately, however policymakers are acutely aware of them. As shown by the actions of the European governments in measures announced on Sunday, global authorities are likely to respond with support mechanisms aiming to improve the tone of financial markets and boost the confidence of individual consumers and corporations. These support mechanisms, just as in the 2008/9 period, are likely to centre on 'quantitative easing' - printing money in order to buy government bonds and hence push liquidity into the financial system. Over the last few days, both the European Central Bank and Bank of Japan have enacted new support programmes, having been overtly sceptical of such mechanisms when the Bank of England, US Federal Reserve and the People's Republic Bank of China were enacting them 2-3 years ago. The big challenge to any successful implementation of such support mechanisms is the current lack of confidence in the European and American financial system.

Our key messages to investors at the moment are –

• We have been aware of the severity of the above issues for a while now and so our portfolios are positioned defensively;
• Continuing high levels of consumer and government debt are a big constraint on global markets and this has influenced both our positions and our asset allocation;
• We have restricted our corporate bond holdings to companies with a more cautious business orientation and more stable cash flows (for example, tobacco, utility and telecoms companies);
• The biggest overweight theme across our funds (with equity exposure) is to overweight precious metals - almost exclusively gold. We added to our positions in gold equities in early and mid June as we saw good value and we have been rewarded for this positioning during both July and August to date;
• We have an emphasis on companies with strong balance sheets, high and sustainable dividend yields and large market positions in their particular business area;
• Finally, and importantly, we have retained well above sized average cash positions in all our funds.

Over the past 6 months (to the end of July), our Close Discretionary Fund performances have been highly competitive. Going forward we believe that our shift towards more direct investing at the expense of third party collective investing, will provide the funds with additional opportunities. As discussed, the macroeconomic pressures are not easily solved but given the indiscriminate nature of the sell-off in equity markets we believe opportunities will be apparent. We believe having a greater direct equity focus will provide us with a better capability to access these opportunities. To this end, we have been carefully and highly selectively adding to a small set of favoured equities.

In conclusion, we have an experienced investment team and we are aware of the challenges presented by the broader global macro economy. From our current relatively cautious positioning, we will be looking to carefully and selectively embrace opportunities. History suggests that the use of support mechanisms like quantitative easing are a net positive for risk assets like equities and tangible assets like gold and other precious metals, although the timing and success of these potential policy moves is still unclear. Most importantly we will continue to stick to the disciplines of research, analysis and portfolio construction across the full range of our investments which have served us well through previous periods of volatility and uncertainty.

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