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7th February 2011

Special Situations

On February 2, 2011 Martin Gray, Manager of the CF Miton Special Situations Fund, spoke with
Tim Price and Killian Connolly of PFP Wealth Management. A transcript of the interview follows.

Tim Price: Is the financial crisis over ?

Martin Gray: I‟m still pretty cautious. I‟ve positioned the portfolio fairly defensively as
we‟ve gone through this crisis, and I‟m happy to stay reasonably defensive in my funds. In so far as
the financial crisis is concerned, I think there‟s more to come. I think we still have a solvency crisis,
more so than just a banking crisis or a financial crisis. I‟m happy to be reasonably defensive at the
moment and see how things pan out.
Tim Price: What would cause you to be slightly more upbeat ?
Martin Gray: One of the key things would be to see unemployment in mature economies
to start decisively to come down. I‟m not seeing or hearing any room for improvement yet in the
UK, Japan, places like that.. We‟ve had very little real wage growth in the mature economies
through the last 10 years, so I think that would be a key metric.
Tim Price: What‟s the objective of your fund, particularly the CF Miton Special
Situations Fund ?
Martin Gray: Quite simply, it‟s a global balanced fund. I look to make money in any areas;
I don‟t run to the benchmark; I‟m looking to make money wherever I can. I don‟t have any limits in
terms of what I can hold, except perhaps in risk.
Killian Connolly: What investment products do you allocate towards in pursuit of the fund‟s
objective ?
Martin Gray: I use a wide range of underlying assets: broadly speaking closed-end funds;
open-ended funds; direct equities; direct bonds, like Gilts; ETFs [exchange-traded funds];
occasionally structured products. Direct equities would usually only be UK equities.
Killian Connolly: And derivatives ? Is the fund exposed to any kind of esoteric products ?
Martin Gray: Nothing particularly esoteric at all. The fund itself has no enhanced powers
so I am restricted in that respect, but that‟s how the fund has always been in its 13-year life, so
why change it ?
Tim Price: Can you say a little about the parent group ?
Martin Gray: It‟s been through quite a lot of change over the last couple of years and it‟s
now a purely asset management business, renamed at Group level MAM Funds. At the moment
there‟s just being completed a placing to clear the bank debt that was raised to buy the Midas
group three years ago. There‟s also three new directors coming on board, replacing a couple that
are leaving the Board now. It sounds like a lot of change but it‟s very much to do with moving
toward a pure asset management business. We‟re looking forward to Gervais Williams [formerly
with Gartmore] joining us in March – that‟s very exciting for all staff.
Killian Connolly: Obviously you managed the fund during the Credit Crisis and during 2008 –
what experience do you take from managing money during that time ?
Martin Gray: It was very interesting times and 2008 was a year I enjoyed for the fund; it
was a good year for the fund. We positioned ourselves probably much too early, in late 2006, for
some problems in the asset markets and 2007 was quite hard work on the back of that, but 2008
was a very rewarding year for the fund where we did manage to make a positive return. I suppose
since then I‟ve continued to be a bit too defensive – going back to what I said earlier, I‟m not
convinced that the banking crisis or the debt crisis is fully solved yet, and there are still some
worries now.. Added to the banking system we‟ve got governments now heavily indebted and
there are still plenty of danger signs going forward.

CF Miton Special Situations – performance since launch

Tim Price: You‟ve alluded to the government debt crisis. There seems to be an
interesting polarisation in the market between Keynesian stimulus and more recently the so-called
Austrian school has become popular with views about monetary policy and governments keeping
out of the way rather than trying to reflate the economy. Do you have any economic bias from a
philosophical perspective ?

Martin Gray: Not especially. I just try and manage the fund as I see it and where I see
opportunities taking into account everything that‟s out there. Pursuing any particular style or any
particular economic style is perhaps a bit too narrow for me. I have to try and make money
through all times I guess, for investors, as well as trying to protect the downside as much as
possible. I try not to be too focused on any one thing or any one area, even if it‟s what I might
basically believe in.

Killian Connolly: Do you support the ongoing coalition government‟s austerity plans ? Do you
think that will create opportunities for the fund ?

Martin Gray: I hope so. From a UK perspective I was very pleased with the austerity plan
because it is tough and it gives them room to flex back a bit on it. The alternatives weren‟t great
for a standalone currency; if Sterling or the Gilt market had taken any kind of hit on the basis that
we were getting out of control, I think that would have been a nightmare. You‟d have seen yields
climb quite sharply and we don‟t want to be following what‟s going on in Spain and Italy and
southern Europe.. I thought it was the right thing to do even though it‟s pretty harsh.
Tim Price: You‟ve mentioned Spain and Italy; what likelihood would you attach to any
sovereign defaults in the Euro zone or elsewhere over coming years ?
Martin Gray: This is down to the populace and whether they‟re going to be prepared to
take the harsh lessons of what they‟re going to have to do. I mentioned earlier no real wage
growth throughout most mature economies over the last decade or so – that hasn‟t been true, of
course, in southern Europe where they‟ve enjoyed a huge kick-up in pay to the point where those
economies are uncompetitive. That has to change. Have they got the stomach for reversing those
25% to 30% wage increases they‟ve taken while the Germans have taken virtually none ? Or are
they going to be on the streets and forcing governments to default on their promises ? It‟s a very
difficult one in terms of what will actually come out at the end of the day; are the Germans
prepared to be the lender of last resort ? I doubt that they are, despite Angela Merkel‟s comments
that she was pro-Euro and they will do all they could. I‟m not sure they would go that far.
Tim Price: Do you have a view on the Euro then ?
Martin Gray: I hold no Euro assets in the fund (or negligible amounts). Deliberately. There
are risks for the Euro over the next few years. I‟m quite happy not to hold Euro assets. That has
had an effect on my asset allocation but I don‟t see much point holding an asset if you don‟t like
the exchange rate of that economy versus Sterling.
Tim Price: Are there any currencies other than Sterling that you particularly like ?
Martin Gray: I‟ve been steadily moving toward Asian dollar currencies over the last 18
months or so. I hold Asian currency funds and bond funds. That‟s as far as I go – I haven‟t got any
Asian equities or property to speak of. But I think there‟s a misalignment there that will have to
correct itself in due course. I also think that Sterling‟s a bit overvalued at the moment and
therefore I‟m quite happy to hold some US dollars. I still think that on any setback the dollar will
benefit as a safety currency though further down the line that may become a little less safe and a
little less attractive. The other currency that I‟ve held long term and since 2006/7 is the Yen,
which I continue to hold. I don‟t think the Yen‟s overvalued. It was at these levels 15 years ago
against the dollar, and since then we‟ve seen inflation in the US over 40% versus negligible in Japan.
Despite their debt situation in Japan I still think it‟s a good currency to hold.
Tim Price: Do you have a view on the Japanese stock market ?
Martin Gray: I have. It hasn‟t proven particularly right in recent times ! I‟ve had a
reasonable weighting, not a huge weighting, towards Japanese equities, for over a year now. I felt
that the DPJ [Democratic Party of Japan] and their focus on domestic policies would be a boon for
the domestic economy. That has turned out to be not so good so far – they lost their first prime
minister in four months and the next one nearly went about five months later. But they seem to
be trying to get domestic policies through; politics is such in Japan that it‟s proving to be quite
hard work, now that they‟re not in control of both Houses.
Killian Connolly: Do you view gold as a currency ? What is your view on gold and silver ?

Martin Gray: I certainly have viewed gold as an alternate currency; back in 2001 I
increased the weighting to gold in the fund to nearly 8% or 9%. Fairly consistently over the last 10
years gold has featured between 5% and 10% within Special Situations. More recently, since the
middle of 2009, I‟ve been decreasing that weighting; now it‟s probably less than 5% of the fund. I‟ve
felt that there‟s a lot of speculation on gold and the price has run away a little bit, and I‟ve been
concerned about the correlation of the gold price with other assets. It has moved in the “wrong”
direction on a number of occasions compared to where it should be going as an alternate
currency, for instance the Dubai crisis when it fell $50 rather than rising $50 in a day. I am a fan of
gold but I‟m not very happy at these levels so I‟d be happy to be underweight where I‟ve been
over the past 10 years – but we have made a lot of money out of gold.
Tim Price: Do you think there‟s any such thing as a safe asset these days ?
Martin Gray: Probably not. There‟s a risk to pretty much anything, isn‟t there ? You might
say that gold is the nearest thing to that because not much sovereign paper these days or
currencies can be viewed as safe with the amount of debt floating around the world. That‟s an
interesting debate – probably one for a couple of bar stools and a long evening !
Tim Price: Do you think QE [quantitative easing] will end, or would you like it to end,
any time soon ?
Martin Gray: I would like it to end, because it is creating extremely false markets in asset
pricing and we‟ve seen correlated movements in all assets – it was pretty hard to find an asset that
fell last year. We saw back in 2009 and last year that as soon as any announcement was made that
quantitative easing was going to be resumed that asset markets have gone through the roof in
anticipation of that. The liquidity has just sent everybody into risk assets, down to the casino –
however you wish to describe it. I would like to see it end and am probably positioned for it
ending, sooner rather than later. But I‟m not sure the Americans have got much alternative at the
moment.
Tim Price: What do you think is the likelihood of a rise in UK interest rates any time
soon ?
Martin Gray: My hope and belief is that there is little chance of that happening, however
there seems to be a lot of media and market views that we should be raising rates sooner rather
than later. I think that would be a disaster. I don‟t think there‟s any necessity for it. Sure, the
inflation numbers are not coming through good, but I do side with Mervyn King on most of the
points he‟s been raising. There are short term problems with food and commodity prices; oil
prices are obviously having an effect, ditto VAT. But I don‟t see any basic long term underlying
inflation. I think it will be under control with patience.. I think the UK economy is in for a tough
time.
Tim Price: What‟s your take on how we end up, in a world that‟s drowning in debt ?
Do we end up with „muddle through‟ austerity; do we end up in a deflationary mess; or do we end
up in an inflationary or very inflationary crisis ?
Martin Gray: Here in the UK I think it‟s austerity, low growth.. Deflation ? Possibly, but
disinflation or low inflation is how I‟m positioned. The inflation thing is a concern but I think we‟d
need another two or three bouts of quantitative easing to really concern me about that.. I think
governments are going to be forced by the populace to tighten things up eventually. I think we‟ll
have a long, hard grind as we clear up this mess.
Killian Connolly: What‟s your view on emerging markets, and China and India as the global
growth drivers ? Do you see any worries on the horizon ?
Martin Gray: Yes, I have a number of concerns that China is eventually going to be forced
to get its house in order. I don‟t think we can see these rates of growth and lending continuing
forever. There are some signs that the Chinese authorities want to slow things down a little bit
but they don‟t seem to be having too much effect so far. We‟re already seeing a little bit of a
setback in emerging markets this year but I think there‟s a lot more to come. I think money‟s just
wholesale flooded in to those economies with quantitative easing and created.. bubble‟s probably
the wrong word, but certainly too much fund flow in the wrong direction where a lot of that
money isn‟t really needed and it needs to flow back again. From my positioning I‟ve got no
emerging market exposure at all – and this is from a fund that in 2007 and early 2008 still had
nearly 20% in Asia and emerging markets, of which nearly half was in China, so I‟ve moved to a
very defensive position from there. I‟m quite happy to be out of those markets at the moment. I
think there‟ll be volatility to come, particularly as they do have an inflation issue and that may lead
to other problems – trade barriers and those kind of horrible things..
Tim Price: On which note, I think we all head to the bar. Martin Gray, thank you very
much indeed.

Tim Price
Director of Investment
PFP Wealth Management
7th February 2011.

Email: tim.price@pfpg.co.uk Weblog: http://thepriceofeverything.typepad.com

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