Hold fire on gold - for now

This portfolio review covers the final quarter of 2010 and Mick Gilligan's immediate outlook for 2011. The portfolio performed strongly as 2010 came to a close, thanks to the market surge in December after the Irish debt crisis ended with a EU bail-out and the US announced more quantitative easing.

Investors started to pile into risky, cyclical stocks again, while defensive sectors such as pharmaceuticals lagged. Government bonds also rallied at the year end.

Overall, the FTSE All-Share index rose by 8.5% during the quarter, while Killik's portfolio repeated the 7.6% gain it had achieved in the previous quarter.

It is now up nearly 50% since inception and the portfolio's performance remains pretty much neck and neck with that of the FTSE APCIMS (Association of Private Client Investment Managers and Stockbrokers) Growth Portfolio index.

With Gilligan's more balanced approach, the portfolio will not match the performance of the FTSE All-Share index when equities are motoring ahead. Also, funds in the IMA's active managed sector can have up to 100% in equities. Gilligan does not expect all his holdings to move in the same direction at once.

Commodities on the rise

The best performance over the quarter was produced by the BlackRock Gold & General fund, which rose 13%. Investors' concerns about currencies and sovereign debt, plus worries about inflationary pressures, resulted in increased interest in commodities, and gold in particular.

Gold bullion prices reached record highs during the quarter. The prices of other precious metals, such as silver, also rose. Evy Hambro, manager of the fund, expects the gold price to continue to be affected by central bank decisions on further quantitative easing in the short term.

But he also expects the metal to retain its attraction as a safe haven in uncertain times and will be a useful portfolio diversifier. He points out that limited supply will also underpin gold's price.

Unfortunately, the BlackRock fund constitutes less than 5% of the portfolio, so its good performance had a limited impact on the portfolio's overall return. However, Gilligan is not inclined to increase his holding. "As fast as the price of gold can rise, it can also rattle back down again," he says.

"Also, there is exposure through funds such as First State Asia Pacific Leaders, which has a gold mining stock as its largest holding."

However, two of the largest holdings also had a good quarter. Findlay Park American Smaller Companies, which constitutes 18% of the portfolio, was up 12.5% in dollar terms and 14.2% in sterling.

Gilligan points out that the fund rose broadly in line with the market. "The US was the best-performing developed market over the quarter, partly due to US economic data proving better than expected.

"With valuations looking reasonable, asset allocators may have decided that they should be a bit less underweight the US than previously. The Republicans' success in recent elections means legislation is likely to be blocked. There will be less legislation and fewer surprises, which should be good for the stockmarket."

The portfolio's largest holding, AXA Framlington UK Select Opportunities, was another good performer, up 11%. Its overweight exposure to industrial companies and its underweight to financials have continued to be of benefit. Its largest holding, Weir Group, was the best-performing FTSE 100 share last year. Another industrial firm, Rotork, has also done well.

Gilligan points out that companies such as Weir Group, that have conservative managements and are not indebted, have been selling into the emerging markets and gaining new customers in China and Latin America, and are seeing good earnings growth.

Opportunity available

Nigel Thomas, the fund's manager, believes plenty of opportunities are available for growth among companies with good management who can deal with change. And he points out that, even if the UK economy doesn't do well, many companies listed on the London Stock Exchange derive significant earnings from overseas.

Offsetting the positive trends was the negative performance of four portfolio holdings. The largest faller was hedge fund BH Macro, which invests in global fixed income and foreign currency markets. Its price fell by 4%, even though its net asset value performance was broadly flat.

A widening in its discount over the quarter to 7% caused the dip, as investors sold out fearing a repeat of its dull 2010 performance this year.

Two bond funds fell in value. Invesco Perpetual Corporate Bond lost 2.4%, while Thames River High Income went down 1%. Gilligan says the Invesco Perpetual fund suffered in the last month of the quarter following a rally in long-dated bonds, since its portfolio was shorter in duration. Exposure to financials didn't help. However, fund managers believe there is value there, particularly in the banking sector.

The final fund to lose money was Cazenove UK Absolute Target, which was down 2%, primarily due to the fact that it has remained short on the mining sector. Gilligan admits he is now seriously looking at selling this fund to enable him to gain greater exposure to more promising areas of the market.

Gilligan believes conditions will be much the same in 2011 as they have been in recent months. "There are likely to be a couple of shocks this year in Europe, probably in Spain, Portugal or Italy.

"Investors will continue to put money into risky cyclical sectors, the emerging markets will continue to do well and corporate earnings will continue to improve.

"However, as the market has run up so strongly, we could see a short-term sell-off, when I may make use of the portfolio's cash holding."

This article was originally published in Money Observer - Moneywise's sister publication - in February 2011.