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Inflation warning

At the end of last year, there was a growing feeling in many quarters that markets had run ahead of themselves and the global economic expansion since the financial crisis was faltering. Investors casting around for a safe place to hide had the option of choosing one of a handful of funds that focus on generating absolute (positive only) returns. Most of these can be found in the flexible investment sector. Then the pandemic struck.

Ruffer is best performing absolute return fund

Looking at the NAV returns that these funds have generated over the past year, the winners are Ruffer Investment Company and Personal Assets Trust. BMO Managed Portfolio, which doesn’t have an absolute return objective, has also done well. Capital Gearing is in fourth place. New Star Investment Trust and RIT Capital Partners just make it into positive territory. Both these funds experienced some discount widening, however, and so their shareholders have lost money over 12 months.

Ruffer Investment Company has just published results for the year ended 30 June 2020. These give some valuable insight into how it topped the table. The managers also have some interesting views on where we go from here.

The managers are allowed a little boast – they have produced positive returns in each of the three major bear markets since the firm began in 1994, making money in 2000-3, 2008 and… so far… in 2020. Key to this was not losing too much when markets dived in March AND making a decent return when markets began to rebound. Some other managers had taken too much off the table.

Gold and option strategies paid off

One of the things that the team are often associated with is a positive stance on gold. The soaring gold price meant that the fund’s position in the LF Ruffer Gold Fund rose by 56% over the first half of 2020, adding 5.1% to the NAV. This wasn’t the biggest contribution to returns, however. The fund’s exposure to the Ruffer Illiquid Multi Strategies Fund, a hedge fund that held positions designed to benefit from a widening gap between yields on corporate debt and government debt, added 6.2% to the NAV. More positive returns came both from options designed to benefit as stockmarket volatility picked up and from options betting that market indices would fall.

The positives were offset by losses on the fund’s equity portfolio, which took 10.5% off the NAV. Unlike some competing funds that had been selling equities, Ruffer held onto positions in stocks. At the end of January 2020, the portfolio had 43% invested in equities. Some of these suffered disproportionately in the COVID-19 sell-off – stocks such as International Consolidated Airlines and the fund’s UK bank holdings, for example. Most of the portfolio did pretty well as markets recovered, however.

Deflation to give way to inflation

The pandemic has hit most economies hard (although some Asian economies, notably that of China, are returning to normal). Given rising unemployment and falling demand, in the short-term we may see widespread price deflation. Ruffer’s managers think the days of resurgent inflation may be upon us fairly soon, however.

Populism, protectionism, tariffs wars and BREXIT are all facets of deglobalisation. The scope to extract cost from manufacturing processes has diminished and looks set to reverse.

The managers note that many businesses were caught out by disruption in their supply chains as the pandemic hit. They will try to avoid a repeat of this by building more spare capacity into the system. This will put pressure on margins unless prices are raised.

Wage negotiations through the ballot box

Income inequality has reached absurd levels and is a significant factor in the rise of populist politicians. Governments are also well aware that voters will not stomach more austerity.

The power of quantitative easing to stimulate economic growth has waned and policymakers have now implemented measures to put money into the hands of consumers and companies. Money supply is increasing. Ruffer’s managers think it will be hard to switch off this tap.

Increasing interest rates to choke off inflation is a sure-fire route to depression, given the enormous debt burden. Inflation reduces the real value of this debt, however. Inflation, not austerity offers the most practical route out of our current mess.

To sum all of this up in the manager’s words: “The roadmap of the last 40 years is unlikely to work; we believe index-linked bonds and gold will be key assets to hold, along with the right mix of equities and credit protection.

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