Most of the talk in the markets in recent months has been of the possibility of deflation, or falling prices, in the developed world. However, Russell (pictured) and Baillie say that central banks are committed to avoiding the latter and investors would be better off preparing for inflation.
The managers say that this dynamic can be seen clearly in Japan, a country in which they have long held a strong conviction and whose equities make up 17 per cent of their £325m trust.
“While a weaker yen is desirable for corporate Japan, one of the side effects of improved competitiveness is that it adds to the deflationary pressures in western economies,” they wrote.
“The effects can be seen in inflation expectations, which remain subdued, and by extension there is less investor demand for inflation-protected assets.”
“Despite this apathy, we continue to believe that index-linked bonds have a valuable role to play in our asset allocation.”
“Central banks have spent five years fighting tooth and nail against deflation and a volte-face at this juncture would severely undermine the credibility of those institutions. It would also be politically unpalatable.”
“Should deflationary pressures continue to mount, then the likely response will be to do more of the same (loosen monetary policy) rather than change tack.”
“For that reason, deflation protection is provided by the Federal Reserve and Bank of England and the responsibility is on us to protect investors from the inflationary risks.”
The managers retain 8 per cent in index-linked gilts and 14 per cent in non-sterling index-linkers as well as a further 8 per cent in long-dated inflation-protected bonds.
The position in non-sterling index-linkers is the second-largest in the portfolio after Japanese equities, although it has ticked down a percentage point since the end of October.
This heavy weighting remains despite a year in which the Barclays global index of inflation-linked securities has lost 3.54 per cent.
Performance of index in 2013
Source: FE Analytics
The bonds have weighed on the portfolio this year, as has gold, which has lost 25.49 per cent so far. The managers have 4 per cent of the fund in the metal, down from 4.8 per cent last month.
Despite the poor performance of these protective assets, the managers have retained their positions, and managed to eke out NAV gains of 9.6 per cent by their own figures.
They have achieved this through exposure to developed world equities in Japan, the UK and the US, in that order. Currency movements – the managers have been long the dollar – have helped over much of the year, too.
The managers say that their concern for capital protection means they have no intention of raising the risk level in their portfolio.
“Looking back over the year, it could be said to have been a satisfactory one for the Ruffer Investment Company; so far we have produced an NAV total return of 9.6 per cent, which is within touching distance of our long-term average of 10.2 per cent per annum since inception,” they wrote.
“In a year when it has been comparatively easy to make money in risk assets, a plodding pace in line with what we have done for the last nine years does not seem like a boast.”
“However, this year’s return has been achieved with less than half our money in equities, which have had to fight hard to make up for tomorrow’s insurance policies.”
“To be respectable absolute return investors, we need to be able to make money in both good and bad times, and the result is that we will usually lag a sharply rising market.”
“Nick Carn recently wrote: ‘There is nothing wrong with a bubble economy as it bubbles along. The prosperity is not imaginary; the champagne one is drinking is real. The trouble is the hangover.’”
“Today’s world may not feel like the giddy heights of the pre-crisis era and perhaps Prosecco is selling better than Champagne, but this equity market rise is built on similar foundations to those which brought about the financial crisis – namely artificially low interest rates.”
“The less-than-cheerful festive message to our investors is that our protective investments, whilst out of favour, are as essential today as they ever have been.”
Data from FE Analytics shows that the Ruffer Investment Company has done very well for investors by taking a cautious approach in the past.
The trust was the best-performing Global Growth portfolio in 2008, with returns of 23.01 per cent. The sector lost 30.13 per cent.
It was also a top-quartile performer in 2011, the next down year for the market, when it lost just 2.8 per cent while its peers ended it down 8.32 per cent.
However, in the more bullish years of 2009, 2012 and 2013, the portfolio has produced bottom-quartile returns, although the worth of comparing the fund to its sector is questionable given that few portfolios take its absolute return approach.
Our data shows that the trust is marginally behind the average Global Growth trust since launch, although its protective qualities mean that investors who have been there from the start have been ahead of their peers for the past five years.
Performance of trust vs sector since July 2004
Source: FE Analytics
The fund has achieved its gains with a little over half the volatility of the sector: 7.55 per cent annualised versus 13.81 per cent.
The maximum drawdown – the most investors could have lost if they bought and sold at the worst possible moments – is just 13.83 per cent on the Ruffer portfolio, compared with 41.97 per cent from the sector.
The trust has an annual management charge of 1 per cent and is yielding 1.55 per cent.
