Russell, who co-manages the Ruffer Investment Company and CF Ruffer Total Return fund, has retained his significant overweight to inflation linked bonds and gold, even though the Fed has confirmed that QE could end in the US as early as this year.
Both asset classes have sold off significantly in the aftermath of chairman Ben Bernanke’s announcement, but Russell says he has no plans to sell out of them as inflation remains an inevitable by-product of the high levels of liquidity in the system. He still believes a consumer price index (CPI) in the high single digits is likely and expects negative real interest rates of 4 to 5 per cent at the very least.
"Nothing has changed our view that central banks’ only option to get rid of the debt is to inflate it away through monetary easing," said Russell (pictured) in an exclusive interview with FE Trustnet.
"The US is recovering a bit better than expected and so are some of the developed markets, but the fact remains that they haven’t done anything about their very high debt levels."
"People seem to have forgotten that. You see a lot of commentators talking about normalisation and the end of QE and rising interest rates, but we’re just looking at this and thinking 'you can’t have normalisation until you get rid of the debt'."
"We see this tapering as one of the speed bumps along the way, but we’re not at the end of QE and the beginning of tightening – that’s a long way off in the grand scheme of things."
Russell acknowledges that worries over inflation in the mainstream are "off the agenda for now", but thinks the market has got complacent if it thinks quantitative easing is genuinely coming to an end.
"Inflation is the only way [central banks] will be able to get rid of the debt – the outlook for growth is no way near enough to make any in-roads, and it’s clear that economies won’t be able to bear the normalisation of interest rates," he explained.
"Everyone is saying UK housing is fine, but it wouldn’t be fine if rates were at 5 per cent."
"Moreover, I think the Fed have a more positive view on the US economy than most commentators. If higher yields on US bonds feed through to the housing market, I think that’s going to slow down the economy anyway, so there’s little they can do there."
"Any slowing in QE and a rise in interest rates is likely to delay the onset of an inflationary outcome, but I think further down the line the lack of growth will see us return to it – most likely because of concerns over emerging markets and Europe, rather than something more US-centric."
Russell points out that QE is still being used in the US and that even if it were to slow later on this year, there are still plenty of other central banks implementing this policy.
"It’s important to remember that other economies haven’t said anything about stopping QE," he said.
"Japanese QE is to a large extent offsetting any potential moves from the Fed. They’re doing almost as much as the US, in an economy a third of the size."
"[In the UK], as far as we can see, [new governor of the Bank of England Mark] Carney isn’t anti-QE, and I wouldn’t be surprised if he pumped some money in pre-emptively to ensure a smooth start."
He adds that much of the liquidity in the system has yet to get off of the banks’ balance sheets, meaning that inflation could happen even after QE comes to a grinding halt.
"It’s the question of the velocity and volume of money. If velocity comes back, then there’s going to be a lot of money in the system, which will breed inflation. This is what we fear."
Gold and gold equities currently have an 8 per cent weighting in Russell's portfolios, while inflation-linked US and UK bonds have a 27 per cent weighting.
These overweights have hurt the performance of the Ruffer Investment Company and CF Ruffer Total Return fund recently, but Russell’s high exposure to Japanese equities and more recently "swaptions" – which are designed to make money from fears over rising bonds yields – have offset some of the pain.
Our data shows that the CF Ruffer Total Return fund has made 13.71 per cent over the last year. The fund's primary aims are capital preservation and increasing investors’ wealth over the long-term; by means of comparison, the fund has beaten its IMA Mixed Investment 20%-60% Shares sector over the period as well as the FTSE British All Stocks index, although it has underperformed the FTSE All Share.
Performance of fund vs sector and index over 1yr
Source: FE Analytics
During the recent pull-back, the fund has performed in line with its sector, but lost less than the All Share.
Russell has used the sell-off in inflation-linked bonds to increase his exposure, even though he thinks in the short-term they could fall further.
"All along we knew there was a risk of a temporary rise in bond yields and real yields before inflation kicked in. It’s pushed back the date of when inflation gets out of control," he said.
"We’ve added to our long-dated inflation-linked TIPs because we think the rise in yields has been overdone. We’ve done it slowly because they’re still falling in value, but we think it was a good opportunity to add some more."
"There is a scenario where our long-dated UK linkers could fall by at least 20 to 30 per cent. It’s unlikely but not impossible, but we’re willing to bear that risk."
"It’s also important to remember that if that happens, it means real yields are rising and global growth is strong, so everything else will be OK. We have 45 per cent in equities, which would do well in a bull market and offset any pain in index linked bonds."
The CF Ruffer Total Return fund has 19 per cent in Japanese equities, 12 per cent in UK equities, 9 per cent in the US, 5 per cent in Europe and 5 per cent in the Far East.
Russell currently has 7 per cent in cash.
He is a little bit more cautious on gold than linkers, believing it is a far more unpredictable asset class. However, he believes it will be one of the few assets that will protect his investors from inflation when the time comes.
Investors may well ask why Russell has such a strong view on inflation even though he himself admits that it could be a long way off. Why suffer short- and even medium-term pain in the meantime?
To this question, the manager replied: "Taking a long-term view is at the very heart of everything we do. If we see a significant risk and can’t time it, we will protect against it regardless. Our emphasis is on capital preservation."
"Historically, this has seen us ride through the hardest times, even if we did have to put up with some pain at certain points."
"We’ve had dull periods where it’s looked like we’ve owned useless insurances. We have no claim about predicting when things will happen. I can understand why people will question why we hold gold or index-linked bonds, but inflation could kick in next week."
"Earlier this year we could envisage a situation where long-dated UK index linkers could fall by 8 or 9 per cent, but we’re not short-term traders," he added.
Ruffer called the global debt crisis years before it struck markets in 2007 and 2008, and suffered short-term underperformance as a result.
The fund lost money in 2006, during which time the FTSE All Share rose by more than 16 per cent; however, this short-term blip was more than made up for when things took a turn for the worse. Our data shows it made more than 20 per cent in 2008, compared with losses of almost 30 per cent from the All Share.
This massive margin of outperformance has contributed to the fund’s strong long-term record, which puts it well ahead of its sector average, the gilt market and the UK equity market.
Performance of funds vs sector and index over 10yrs
Source: FE Analytics
Russell believes high levels of inflation will cause havoc across bond markets without inflation protection, and are likely to herald the rise and fall of a severe bubble in equity income. We will hear more from him on this topic in an article later today.
One last factor that could accelerate the rate of inflation is the social and political unrest occurring across a number of different countries at the moment, Russell says.
"It’s puzzling that we see all this unrest, which presents us with a disturbing background [to the markets]," he continued.
"It hasn’t really been seen at elevated levels in European countries that have suffered very real pain, like the UK, Portugal, Ireland, Greece and so on. There’s been a lot of suffering, and not a lot of open rebellion."
"I am nervous that what we’ve seen in Brazil and Turkey could spread, which supports an inflationary-led outcome, because politicians will eventually give in, and replace austerity with easing."
"The rise in inequality doesn’t look sustainable. Inflationary mechanisms will put that right."
The £2.9bn CF Ruffer Total Return fund requires a minimum investment of £1,000 and has an ongoing charges figure (OCF) of 1.53 per cent.
