The stable inflationary environment of the past 30 years has led to a “a problem of imagination” among investors, according to Hamish Baillie and Duncan MacInnes of the Ruffer Investment Company, who warn nobody under the age of 60 has had to cope with a situation where the value of their assets is eroded in the short term.
Baillie and MacInnes aim to provide consistent positive returns “regardless of what the market or economy throws at [them]”. The managers weathered the coronavirus crash well, with the Ruffer Investment Company up 7.56 per cent this year compared with losses of 9.03 per cent from its IT Flexible Investment sector and 17.25 per cent from the FTSE All Share.
Performance of trust vs sector and index in 2020
Source: FE Analytics
Yet while they neatly side-stepped the short-term impact of Covid-19, they said it is the long-term changes set into motion by the virus that will be their real test.
“The world today, in lockdown, is unequivocally deflationary but the solutions are unequivocally inflationary,” the managers explained.
“There is an epoch-defining tug-of-war going on between the unprecedented interventions of governments and central banks versus the unimaginable disruption to the functioning of the global economy caused by the pandemic.
“One of the most obvious consequences is that the inflationary endgame is closer and more likely than it was six months ago. Borrowing is currently going through the roof in order to fund the emergency measures put in place by governments.
“Previously, one might have said that keeping interest rates below the rate of inflation (financial repression) was desirable, now it is a necessity if these promises are going to be affordable.”
They added: “A significant change of the last six months is that politicians rather than central bankers now have their hands on the steering wheel and they have an entirely different set of objectives and incentives.”
Baillie and MacInnes said that one of the biggest problems with high inflation – aside from the fact few current fund managers have experience of working in such an environment – is that it is very much a behavioural phenomenon: if people know their money will not be worth as much tomorrow, they will go out and spend it today.
And, while these expectations currently lie dormant, they can quickly become self-reinforcing, as was seen in the early days of the lockdown in the UK when there was a rush to exchange money for the goods on supermarket shelves.
“At its simplest, inflation is caused by too much money spent chasing too few goods,” the managers continued.
“On top of this, austerity is dead and fiscal spending is here to stay. What’s more, it is currently being financed by central bank money printing. It doesn’t matter whether it is the political left or the right in power – they all have their own expensive plans to stimulate and get the economy going again.
“From the US Democrats’ Green New Deal or Medicare-for-All, Trump’s coronavirus stimulus cheques, to Rishi Sunak’s furlough schemes, bounce-back loans and stamp duty holidays, the spending rabbit is well and truly out of the hat.”
The managers warned the problem with printing money is one of control – once voters know that unfettered money can be bestowed so easily, politicians will suffer greater pressure to create more. Or as US economist Milton Friedman put it: “Nothing is so permanent as a temporary government programme.”
Baillie and MacInnes said that an extended period of interest rates being held below the rate of inflation is “an environment of financial repression”. However, while there has already been a decade of this, they think it is going to get worse.
“In short, we are entering a new regime, and in contrast to the world we have lived through, it will favour labour over capital and will be less friendly to the asset owner,” the managers said.
"This means our job of protecting our shareholders is getting harder, but it also makes the answer clearer, more certain.
“The solutions to the crisis this time have resulted in money being injected directly into the real economy and people’s pockets, those companies and citizens who desperately need it and will spend it.
“Quite the contrast to stimulus being stuck on bank balance sheets as happened in the aftermath of the global financial crisis.”
The managers believe the fallout from the coronavirus crisis will eventually result in heightened economic and market volatility, as well as more inflation.
With all of these trends bad for asset prices, investors will need a portfolio that looks very different from one that has served them well over the last couple of decades. In particular, Baillie and MacInnes said it will need to contain index-linked bonds, gold and value stocks (which benefit from stimulated GDP growth) as well as “a significant sprinkling of protection against market calamity”.
“We have survived the initial onslaught, but this story is not over; economic events have gone from a jarring spectacle to a corrosive malaise which will play out over the coming months and maybe years,” they added.
“At Ruffer, our approach has always been not to try to precisely time events, but to position our portfolio in anticipation of the environment we believe will inevitably emerge.”
Data from FE Analytics shows the Ruffer Investment Company has made 40.86 per cent over the past decade, compared with 80.56 per cent from the FTSE All Share and 46.98 per cent from its IT Flexible Investment sector.
Performance of trust vs sector and index over 10yrs
Source: FE Analytics
The trust is trading at a discount to net asset value (NAV) of 2.38 per cent, compared with 2.9 and 0.85 per cent from its one- and three-year averages. It has ongoing charges of 1.13 per cent and is not currently geared.