Markets will be dictated for the next decade by government attempts to erode their staggering debts with inflation, according to Ruffer’s Steve Russell
The FE Alpha Manager believes there is no way Western governments will be able to pay back their unprecedented levels of debt in real terms, and will instead call upon negative real interest rates to do the job for them.
Russell warns that the strategy could see inflation approach the 10 per cent mark in the UK, and result in a 1980s-style global recession – far worse than the one we are currently experiencing.
“For some time before the crisis, the only question you needed to ask was ‘is there too much debt’”? Given our focus on capital preservation, we took measures to protect against this risk,” explained Russell.
“Since the crisis, there’s also just one question: “Can the debt be repaid?” In short, we think the answer is no – in some way or another, the debt was always going to be defaulted on.”
“As soon as they started printing money and slashing interest rates, it was clear that a “stealth default” would occur by means of inflation, rather than an all out default like we saw in the 1930s. Negative real interest rates reduce the real value of debt, so effectively we’re taking the easier way out.”
Russell, who heads up the CF Ruffer Total Return
fund and the Ruffer Investment Company
, thinks this environment will be very difficult for Western markets, and as a result has taken big positions in index linked bonds, gold and the US dollar.
The manager thinks UK inflation, for example, could get up to the “high single digits”. However, he believes eventually governments will have to change their policy.
“I don’t know how long this [inflationary period] will last for, but it could be a very boring time to be an equity investor,” he explained. “It will get to the point when inflation becomes more of a problem than debt and governments raise interest rates. This is likely to puncture the bubble in companies which have done well during inflation, such as food companies, and could result in a recession akin to what we saw in the 1980s.”
“What’s more likely is that investors realise that their money is being devalued and once that happens, there will be a rush to spend – most likely in index linked bonds or gold as a source of protection.”
This is Russell’s rationale for holding 38 per cent in index linked bonds in his CF Ruffer Total Return fund, split half and half between US treasuries and UK gilts, and 7 per cent in gold and gold equities.
While a 1980s-style recession is certainly not an appealing prospect, Russell believes it would carry a silver lining.
“The recession would be painful, but by no means terminal,” he said. “It would give economies a clean slate.”
The manager says he is cautious on equities in general, though he sees the Japanese market – which is a significant overweight across both his fund and trust – as an exception.
He commented: “We have this position for three reasons: firstly, because at last the market looks cheap, with the dividend yield above the US and company debt significantly lower than it was.”
“Secondly, because we believe the Bank of Japan is finally serious about stimulus spending and inflation targeting; and lastly and most importantly, because unlike the West, we believe the Japanese market would be a beneficiary of inflation, particularly for businesses that have not seen top-line growth for many years.”
In spite of his wariness of Western markets, he says the sudden spikes in performance means a manager cannot afford to bypass equities completely.
According to FE data, Ruffer Total Return has 16 per cent in Japanese equities, which compares to 12 per cent in the UK and 9 per cent in the US. T&D Holdings and Mitsubishi UFJ Financial Group are both top-10 holdings.
Performance of fund, benchmark and sector over 5yrs
Source: FE Analytics
Ruffer’s macro calls have been very effective in the last five years of crisis. The firm correctly called the 2008 style-crash – albeit, a couple of years too early – and also took part fully in the 2009 and 2010 rebound.
“Prior to 2008, we held assets which we believed would protect against the downside in a worst case scenario, but not lose us money,” said Russell. “These included Swiss government bonds, gold, Japanese yen and UK short-dated gilts.”
“Thankfully for us they all worked, and we did very well in 2008 – indeed, we didn’t expect to make as much money as we did.”
“In 2009, we managed to take advantage of the upside, thanks largely to calls made by our chief economist Peter Warburton. We took the view that the markets fell based on inventory factors, and so felt the markets would rebound – not necessarily to levels before the crash, but a significant amount.”
In 2008, the fund returned 20.88 per cent, when its sector average lost 15.84 per cent. In 2009-2010, Russell delivered 25.8 per cent, marginally beating its sector.
Russell upped his exposure to equities from around 30 per cent to 50 per cent in 2009, which was brought back down to 40-45 per cent at the latter end of 2010.
The manager co-manages the £2.4bn CF Ruffer Total Return portfolio with fellow FE Alpha Manager David Ballance. The fund has a minimum investment of £1,000, and a total expense ratio (TER) of 1.54 per cent.
Russell heads up the Ruffer Investment Company with Hamish Baillie, who replaced chief executive Jonathan Ruffer earlier this year. The industry legend still has a role in determining the firm’s investment strategy, however.