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Donald Trump’s election as US president, coupled with the UK’s planned exit from the European Union, are pushing the world closer to the ‘inflationary denouement’ that Ruffer fears.
According to Ruffer Investment Company’s (RICA) managers Steve Russell, Hamish Baillie and Duncan MacInnes, these two developments have made government intervention to stimulate economic growth and raise inflation politically acceptable.
Alongside spelling bad news for savers and investors, the trio warn that fiscal stimulus of tax cuts and increased spending will bring additional challenges. ‘Should these policies to promote growth prove successful, even if only in the short term, then it is highly likely that bond yields will continue to rise and unless this is accompanied by higher inflation expectations then index-linked bonds will suffer,’ they said in the trust’s half-year report.
In this scenario, the managers would face a conundrum because 28% of their defensively-positioned fund is invested in index-linked bonds which they have used to protect investors from the threat of inflation since 2010.
‘The right place to be invested for the long-term could look like the wrong place to be in the short-term and the timing of a shift from one paradigm to the next is unknowable,’ the managers noted.
Their answer is not to cut back on index-linked bonds, but rather to invest the £378 million fund in areas that can offset any impact over the short term. These include shares with economic sensitivity, known as ‘cyclicals’, alongside interest rate options.
In Ruffer’s six-month report to the end of December 2016, Russell, Baillie and MacInnes said the move out of ‘expensive defensives’ within the equity portion of the portfolio was largely complete. They also sold out of aerospace company Lockheed Martin (LMT), following a 171% increase in its share price.
The team increased exposure to oil stocks after adding Statoil (STO) and Imperial Oil (IMO) to the portfolio. These positions sit alongside Exxon, Aker and Emerson. Following the sell-off in domestically-focused companies post-the Brexit vote, the managers added housebuilder Barratt Developments (BDEV) and Lloyds (LLOY). Equity allocations remained below 40% of the broader portfolio.
In September, the duration of the portfolio’s UK index-linked bonds was shortened, reducing the trust’s sensitivity to rising interest rates.
Over the six months to December, Ruffer’s share price rose by 11.9%, ahead of the underlying 8.3% increase in its investment portfolio, as the fund found favour with cautious investors. During this period, the managers said Japanese shares, interest rate options and cyclical equities had contributed to performance.
The decision to hedge overseas assets back to sterling detracted from performance, however. This was because the team wasn’t able to benefit from the strengthening of other currencies, not least the dollar, in comparison to sterling. Looking ahead, the managers are happy with the trust’s 87% sterling exposure, given the threats posed by upcoming elections in the eurozone.
Ruffer shares currently trade at a 2.2% premium above their net asset value (NAV). Over the year to 28 February, its share price has risen by 21% with dividends included, while the NAV, which measures the value of its investments minus its debts, generated a total return of 17.3%.
According to the company, since launch on 5 July 2004 up to the end of 2016, its NAV grew by 182.4% including dividends, beating the 175% total return from the FTSE All-Share index and the 67.5% gain in its official target return, which is to double the Bank of England interest rate, currently at an all-time low of 0.25%.
It famously made money for its shareholders in the financial crisis with total returns of 23% and 22% in 2008 and 2009 although its investors incurred small losses in 2011 and 2015.