Mark Dampier: Going short on bonds has yet to pay off, but I'm keeping faith

Going short allows an investor to benefit from falling prices, but when prices rise, the short position hits performance

Mark Dampier
Friday 29 January 2016 22:49 EST
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Constructing a good investment portfolio takes time,partly for researching individual investments but also to arrive at the right allocation of your money across each asset class – equities, fixed interest and cash – or geographical region. This is vital to ensure a balanced and diversified portfolio. Unfortunately, few do it well.

For investors struggling to get their asset allocation right, I have two pointers. First, it is not enough to focus on geographical diversification. This will not shield a portfolio from global issues, as illustrated perfectly in 2008. The world is so interlinked that if one area suffers difficulties, particularly a large economy such as the US or China, the reverberations are felt across all global markets.

Second, consider the correlation of the portfolio's constituents. If equities are performing badly, it will hurt performance less if the portfolio has a decent bond allocation – and vice-versa. It is also good practice to ensure that exposure to a particular area is covered by at least two funds, where each manager takes a different approach. In general, this should help shelter an investor from isolated losses – although, there are exceptions; in 2008 almost all investments, apart from bonds, fell in value.

Investors who prefer to leave these decisions to an expert have a range of mixed-asset funds to choose from – among them, Artemis Strategic Assets. William Littlewood, the fund's manager, has the ability to invest in virtually any asset class, including currencies and commodities.

Since the fund's launch five years ago, it has not fared well compared with many of its mixed-asset peers. This can, in the main, be attributed to the manager's large "short" position on government (predominantly Japanese) bonds. Going short allows an investor to benefit from falling prices, but when prices rise (as they have done for bonds over this period), the short position hits performance.

Elsewhere, however, Mr Littlewood's equity and currency investments have been positive for performance.

His reason for shorting government bonds is simple: he believes the large amount of debt created by Western governments via quantitative easing (QE) will eventually result in one of two outcomes: either the debt will go unpaid – they will default on their payments to bondholders – or there will be hyperinflation. In the first scenario, bond prices fall to zero as they become worthless; in the second, they fall as yields rise to compensate for high inflation.

In line with this view, Mr Littlewood has also invested around 8 per cent of the fund in gold. As QE continues to devalue currencies, and governments increasingly look to raise taxes to cover budget deficits, he expects demand for gold to increase.

Mr Littlewood also holds around 5 per cent in platinum, which, in addition to providing a store for wealth, has industrial uses.

His view on bonds has so far been proved incorrect, but he has been steadfast in his belief. If and when government bond prices decline, this fund should profit nicely from the fallout.

In the meantime, though, the short position will continue to drag on performance. So why hold this fund? Because it does something very different to most others. Indeed, I hold it in my self-invested personal pension (Sipp) for this very reason.

As I mentioned, I don't want all parts of my portfolio moving in one direction – which means accepting that some investments will be performing poorly at any given time.

Provided the investor understand what is going on under the bonnet, this should not cause concern.

Put simply, the Artemis Strategic Assets fund fits into the "insurance" side of my portfolio. Central banks are running out of ammunition – they can't drop interest rates much lower and QE is getting less effective with each new wave. My concern is they will fall into the next recession without any firepower. What might happen then is anyone's guess.

Mark Dampier is head of research at Hargreaves Lansdown, the asset manager, financial adviser and stockbroker. For more details about the funds in this column, visit hl.co.uk

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