While it remains difficult to protect against “ordinary setbacks” in markets, investors should continue to build protection into their portfolios as markets move into a much harsher environment, according to Jonathan Ruffer.
Ruffer, chairman of Ruffer LLP, said he acknowledged that the firm had let people down in 2018 after its strategies failed to defend investors from short-term market’s falls but was “fully prepared for the battles ahead”.
“The weakness in markets reflects the passing of an inflexion point of mood,” Ruffer explained. “From a sensation that we’ve been living through extremely benign investment conditions and that now we have moved into a much harsher environment.”
Many funds struggled to deliver positive returns last year as volatility returned to markets more sensitive to tighter monetary policy and trade disputes between the world’s two largest economies: the US and China.
The firm’s flagship £3.2bn LF Ruffer Total Return fund – co-managed by FE Alpha Managers Steve Russell and David Ballance – delivered a loss of 6.47 per cent last year, greater than the 5.1 per cent fall for the average IA Mixed Investment 20-60% Shares peer.
Performance of fund vs sector in 2018
Source: FE Analytics
Ruffer said the firm’s strategy has been to retain limited exposure to equity risk combined with “powerful protection”, however, this is unlikely to protect performance during limited falls.
“It is hard to protect risk assets from ordinary setbacks – everybody knows these can happen routinely and protection against them is prohibitively expensive,” he explained.
“Our central belief is that there lies ahead of us market conditions which are capable of causing permanent damage to people’s wealth, and our absolute preoccupation is to prepare for this, while continuing to accept that the timing is uncertain.”
One of the main reasons for underperformance in 2018, Ruffer said, was falls on average of 14 per cent in its equity allocation, which made up around 40 per cent of portfolios in 2018.
The veteran investor said there had been little chance of diversifying into ‘pockets of strength’ given that 90 per cent of all asset classes fell in dollar terms.
While the momentum trade (made up mainly of growth stocks) outperformed during the first half of the year, the latter half was dominated by safe, “no surprise” companies that did not commercially “put a foot wrong”, according to Ruffer.
However, such stocks are “dangerously expensive” and offer limited opportunities for outperformance. As a result, the firm concentrated instead on troubled value stocks – including cyclical and financial names.
“With every sign of a late-cycle boom in the economy, which benefits the earnings of cyclical companies, and accompanied by higher interest rates, which assists the financial industry, we concentrated on these,” said Ruffer.
“We were not wrong on the economic growth, nor the interest rate rises, but the market has savaged the value stocks.”
Performance of indices in 2018
Source: FE Analytics
As the above chart shows, the MSCI World Value index struggles last year falling by 5.24 per cent compared with a 0.28 per cent rise for defensive equity sectors.
However, as the losses from the equity portfolio eroded performance last year Ruffer decided to add more defensive assets to the portfolio.
Ruffer said it has been increasing exposure to gold even as prices have been creeping up in recent months, although greater value has been found in stocks rather than bullion.
“The mining companies’ share prices have been in long-term decline and have reached that happy-hunting ground where the enemy of stock appreciation is not bearishness, but indifference,” he said.
“Gold is an opaque and shadowy investment – many refuse to admit it is an investment at all – and so its early signal of a positive response to difficult markets generally is a hopeful sign.”
As the below chart shows, while gold bullion prices rose last year the FTSE Gold Mines index – which tracks the performance of gold mining companies globally – was down by 4.63 per cent, in sterling terms.
Another area that the firm has been increasing exposure to is inflation-linked bonds, having added US Treasury Inflation Protected Securities (TIPS) to its portfolios.
While there are signs that a fall in markets could lead to a deep economic contraction, which could lead to more deflationary pressures, Ruffer is not convinced such an environment would emerge.
Performance of indices in 2018
Source: FE Analytics
“The inflationary tinder is dry,” he explained. “The western world, excluding much of Europe, enjoys full employment. Its hand–maiden is a newly energised and militant work force in France, Germany, the US and Britain – wages in the UK are rising at an annualised 3.3 per cent, the highest for 10 years.
“This is no time for a gift of easy money from the Federal Reserve in America.”
Despite their name, however, inflation-linked bonds are not responsive to the onset of inflation, said Ruffer: the bonds will fall if rates are hiked to stave off inflation.
But given the ultra-low rate environment of the post-financial crisis world they could perform well against a backdrop of more normalised rates.
It may yet be too early given the weaker market backdrop, but that could change if inflation were to reappear. Interest rates, Ruffer noted, would lag the inflation rate.
“This is the catnip for inflation–linked bonds: they are geared to the difference between the after–tax yield on money, and the inflation rate,” said Ruffer. “In short, they are an essential ingredient: for the next–but–one move.”
Such positioning might take some time to pay off, however, particularly in more challenging conditions in 2019. As such investors need to remain patient and avoid trying to be right, something Ruffer believes can put investors’ cash in jeopardy.
https://www.trustnet.com/news/824565/jonathan-ruffer-we-are-fearful-of-being-entirely-right
“Noah got it right, and well done him,” he concluded. “His story rather glosses over the many months when he was laughed at for his initiative – it is not the laughter we fear; it’s pushing hard to be right and ending up being wrong.”