ETF Portfolio: No need to be defensive

In the two months and 10 days since I last commented on this notional portfolio of exchange traded funds, not much seems to have changed. Greece is still teetering on the edge of default, major sovereign bond issuers have been downgraded by at least one credit rating agency, and UK retailers are still going to the wall.

There is a difference, though. Equity markets in Europe and the USA appear to be taking all this in their stride, at least for the moment. And this has had an effect on the portfolio, which has suffered for its rather defensive stance, focusing on precious metals and bonds (see table below).

In addition, the portfolio's exposure to emerging markets has hardly been sparkling either, since this fund has reflected general disenchantment with markets of this type, because of their exposure to austerity-driven Western economies for the export demand that sustains their economies.

The upshot is that the portfolio has seen a slight deterioration in performance, from a change of -6.9% since inception to one of -7.4%, even including a modest amount of dividend income from two holdings. The market, having been down 6.6% last time round, is now down 4.4%. These are not big numbers, but they do pose some questions for the portfolio's asset allocation.

If I'm not entirely relaxed about the situation, at this stage no tweaks to the portfolio seem necessary. Although the recent rally in the FTSE 100 (UKX) feels solid, logic suggests it may not last. Economic news remains as dire as ever.

The only bright spot is that it is so bad that it may goad the leaders of the eurozone into doing the right thing and making the European Central Bank a bona fide lender of last resort and monetise a proportion of troubled governments' debts. It is analogous to when the UK was forced out of the European Exchange Rate Mechanism in 1992. Government policies became unsustainable to the point of being laughable, and the market forced a solution.

The current debacle is both bigger and more complex, but the same imperative applies.

Before that solution is devised, however, there could be some rocky times for the equity markets, and consequently I believe a policy of defensiveness is the only stance to take.

The role of gold has been largely forgotten. My personal exposure to this market is now wholly through the indirect means of a sizeable holding in a fund of gold shares, rather than physical bullion. So I still think gold looks interesting. The price has weathered a significant setback and consolidated a little under its present price. The current strength in the dollar makes this an even better performance than it might seem (gold's price often drops back if the dollar strengthens).

Metals analysts canvassed by the annual London Bullion Market Association survey are on average expecting further 10% strength in the price in 2012, to a level of around $1,766 (current price $1,662). The average forecast high for the metal among the 26 firms surveyed is $2,055 and the average forecast low is $1,443. That gives roughly a 2:1 ratio of upside potential to downside risk, which seems quite a good ratio to me, particularly given the rumbling crisis in the eurozone.

So the portfolio's exposure to the metal stays.