Burdett's Caution

As we approach the end of 2007 many markets are wrestling with volatile conditions and seem undecided as to whether they can hold the interest cut rally or capitulate to the potential severity of the credit crunch. This is the first year in 5 that we have seen such tumultuous conditions - will 2008 continue in the same vein? Where are we positioned as a consequence?

At the time of writing news flow is deteriorating in all major asset classes and even the popular press are forecasting doom and gloom today on their front pages. This news flow is likely to deteriorate further before it gets better as commercial property auctions get difficult, as interim finance arrangements triggered by the sub-prime crisis in July reach critical rollover points and as equity investors mark time before committing funds. On the corporate front the year-end statements from the financial sector are awaited with trepidation. Will they 'kitchen-sink' their dubious exposures under their new CEOs? Will they seek to spring clean and offload at any price before announcing? We will hear very soon from the US Investment Banks first, due to their November year-end, as they report their full year figures in the last weeks of the year.

Unsurprisingly our portfolios are therefore currently relatively defensively positioned with cash balances running significantly above the norm. Within our fund selections, the combinations we have chosen deliver a portfolio with a greater exposure to larger companies than for many years, and the underlying businesses on average have earnings which are less economically sensitive than the Index as a whole, and that the managers believe are more repeatable and visible – qualities we expect the market to value quite highly during this phase. For the same reasons we have less direct small company exposure than for some time, and asset allocation amongst the markets of the world is less skewed than in recent memory.

However at some point this period of introspection that the markets are going through will pass and there will come a time when bottom-fishing becomes a value-adding strategy rather than a value trap. A number of our managers have started to dip into the beleaguered financials, some are predicting a return to property stocks soon and there are even those bond investors who are expecting to go back to sub-prime debt at some point in the not-too distant future at bargain levels. We will be watching carefully for the correct moment to move to overweight the more optimistic fund managers as we enter 2008.

In summary, the key to our management style at present is flexibility within a cautious overtone. As the gloom reaches the tabloid front pages as it did earlier this month, an efficient market should be close to discounting the worst outcomes and there will come a time to revisit the value opportunities that might present themselves to us. As ever, we are seeking to blend together managers who will be able to best help us to capture the best of these returns for our investors.