Ruffer investment trust faces a rough patch

Jonathan Ruffer founded Ruffer, the wealth management company that bears his name, on the maxim that “investors like making money, but they hate losing money more”. In 2004, the firm launched the Ruffer Investment Company (RIC) to allow private investors who weren’t clients to climb on board.

The trust’s focus is on wealth preservation, which means sacrificing returns on the upside to limit “drawdowns” on the portfolio. A drawdown refers to the paper loss, from peak to low point, incurred by a portfolio when valuations go into decline.

Drawdowns of equity markets and nearly all other assets are recovered sooner or later, but short-term anxiety often replaces long-term equanimity when personal wealth seems to be dissolving. So investors tend to panic at market low points, selling out just before valuations rally.

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Fending off market downturns

Based on its record of a 15% return over five years and 8% over three, the £440m RIC (LSE: RICA) does not appear to justify an investment. However, Hamish Baillie, the fund’s leading manager, points out that its objective is “to seek a return significantly greater than cash without losing money on a rolling 12-months basis from a mix of predominantly conventional asset classes, such as global equities, bonds and currencies, but also some derivatives for protective purposes where necessary”.

Moreover, since launch in 1994 the compound returns of Ruffer’s funds at 8.8% per annum have been significantly greater than the All-Share’s 6.4%, without a significant impact from bear markets.

Since RIC’s launch in 2004, it has returned 209% compared with 164% from the All-Share index. The maximum drawdown has been just 8.6% against 47.7% for the All-Share index. There have been down years; -1% in 2015 and -6% in 2018, but RIC made excellent returns in the 2008-2009 financial crisis. In the first four months of 2020, returns were 5.7% against -19% for the All-Share index. RIC outperformed not just on the way down in the first quarter, but also in April’s recovery.

Returns this year have been driven primarily by credit protection and option protection (profiting from rising yields on corporate bonds, falling equities and rising volatility). The allocation to gold and gold equities has also added value, as has that to index-linked bonds, but the allocation to equities has cost performance 11.6%.

That loss came from an equity allocation of just 40%. The 4% contribution to returns from option protection came from an allocation of just 1% and the positions were all sold at or near the market lows.

The 7% contribution from credit protection represented a 90% return from an 8% allocation. RIC has been “spending a couple of percent a year on credit and option protection in the last few years, so it has felt like driving with the handbrake on.”

Now, co-manager Duncan MacInnes says, “there is a tug of war between an unprecedented stimulus and an unprecedented slump. Equities are not necessarily the answer, but government bonds may not offer protection. Inflation will be the end result of all this”.

Recent years, he believes, have favoured capital – both debt and equity – over labour, but low interest rates and quantitative easing have driven a bubble in asset prices, with asset prices diverging from the economic fundamentals.

Gauge the political mood

“In the very long term, it is right to own equities, but they can spend long periods of 15 years or more in the wilderness. Before the 1950s, equities were not an exciting asset class.” In addition, “starting points matter. The expected returns from here are [just] 2.5% per annum before inflation... Despite the coronavirus crash, valuations are still high”.

In particular, he warns against “being caught on the wrong side of a political and social mood after a crisis. The environment is changing – against buy-backs and excessive corporate pay, towards resilience and robustness, from shareholder capitalism to stakeholder capitalism”. Ruffer likes Japan, where 56% of firms have net cash. Favoured stocks include Ocado, Tesco, Lloyds Bank and ArcelorMittal. Government bonds have been “an amazing portfolio asset”, outperforming equities since 2000 while being negatively correlated to them, but Baillie and MacInnes are wary now.

“Valuations are so high that they need very optimistic assumptions to perform, implying deeply negative yields everywhere.” Besides, the negative correlation with equities, only apparent since the 1990s, has been the exception to the rule in the last 200 years. “We think [it] is unlikely to hold.”

Instead, 36% of the portfolio is in US and UK inflation-indexed bonds, providing protection against the inflation they expect to emerge from so much stimulus. The only way for governments to bring down the huge debts incurred as they ramp up spending is “to keep the cost of borrowing below the rate of inflation”. Eleven percent is invested in gold and gold equities, 12% in credit protection and options, 29% in equities and 12% is in cash and short-dated bonds.

This sounds compelling for investors who have had a nasty scare and fear a second lunge downwards in equities. The inflation thesis is highly credible, gold is doing well and Ruffer’s expertise in protection strategies is proven.

Too bearish?

However, what is not clear is why 72% of the portfolio is in or hedged into sterling. Exposure to the euro is zero and to the dollar negligible. It also seems that they aren’t good at equities. Poor stock selection led to significant underperformance earlier this year and yet when presented with the opportunity in May to buy cyclicals at the bombed-out valuations they were waiting for, they missed it.

Their theory that investors will reward firms pandering to populism at the expense of profits sounds naïve and the rationale for their favoured stocks is underwhelming. Perhaps they are so locked into a bearish view that they can’t see the opportunities. A continuation of the dull returns of the last five years looks more likely than the excellent record of the previous ten.