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Alan Brown, group chief investment officer with Schroders Investment Management, in Toronto on Dec. 12, 2011

Deborah Baic/The Globe and Mail

Investors should batten down the hatches as the storm raging through the euro zone creates the most challenging market environment in four decades, says the chief investment officer of a giant British investment firm.

Cash, gold bullion and corporate bonds, as well as high-quality, dividend-paying stocks, are the best candidates to weather the tumult, said Alan Brown of Schroders Investment Management Ltd., which oversees about $300-billion (U.S.) in assets globally.

"I am very nervous," Mr. Brown said. "This is the most difficult environment for a money manager in the nearly 40 years that I have been in this business … It is dependent upon political actions in Europe where there is a game of chicken going on."

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Leaders of the European Union, with the exception of Britain's David Cameron, last week agreed to forge closer economic ties and impose penalties for countries exceeding deficit limits, but many economists worry that the continent has sentenced itself to years of grinding austerity. Germany, Europe's largest economy, firmly opposes bailouts by the European Central Bank (ECB) or euro bonds that would be jointly backed by all members of the EU.

"I think 2012 looks like a judgment year," Mr. Brown said in an interview. "I don't believe we can keep staggering from crisis to crisis … On one side, you have the horror story of a double-dip recession, and the wheels coming off the euro-zone bus. The other is the possibility that we muddle through with low economic growth."

Mr. Brown expected little from the summit, but still wound up disappointed at the outcome, which he believes does nothing to solve the fundamental issues.

A stumbling block is Germany's fear of inflation, which wreaked havoc on the country in the 1920s, he said. That is preventing measures, such as wide-scale bond purchases by the ECB, that could help bring down interest rates for some of the continent's debt-strapped members, such as Greece, Italy, Portugal, Ireland and Spain.

"The Germans would like to keep all current members of the euro zone in the euro zone," he said. "They don't want to pick up the bill, and they don't want the ECB printing money because of their understandable fear of hyper-inflation. I fear that it is not possible to achieve all of those three goals."

In a best-case scenario for Europe, "we see the euro zone in a recession, a high probability that the U.K. will be dragged back into it, and weak economic growth as a whole," he said. "We have a forecast of the euro zone [GDP]shrinking next year by 1.8 per cent."

While there is a "high probability" that Greece will leave the euro zone in two to three years, the breakup of the euro zone is not inevitable, he insisted. "The ECB, if unleashed, could create a firewall to give those countries the breathing space they need to organize their affairs. But in the absence of that, we remain at risk."

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Mr. Brown is "fairly confident" that equity markets will not be at current prices by the end of next year. "They will either be a lot lower, or a lot higher," he predicted. "You don't bet everything on one of these scenarios. That is too much like going to a casino."

Gold bullion is one way for investors to diversify because the metal is a "hedge against disaster," he suggested, while investors should avoid European stocks and invest in high quality, dividend-paying stocks in the United States, Canada and Asia. "Corporate credit in North America also looks like a pretty good place to be because the corporate balance sheets look to be in pretty good condition."

In Schroders' free-to-roam portfolios managed for pension funds, about 15 per cent is in cash, 6 per cent in gold bullion, 33 per cent in dividend-paying stocks, while the rest is largely invested in corporate bonds, he said. "We think that you should keep a defensive position…We see no reason for trying to anticipate a resolution in Europe."

Schroders' forecast for GDP growth in 2012

Euro zone: -1.8 per cent

U.K.: -0.50 per cent

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U.S.: 1.6 per cent

World: 1.8 per cent

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