Founder Jonathan Ruffer and his team of highly rated managers – including FE Alpha Manager Steve Russell (pictured) – argue that inflation will define the investment environment over the next decade to come.
They see quantitative easing as a tool to inflate debt away, predicting that it could send the rate to as high as 9 per cent. Ben Bernanke’s talk of tapering QE in May and June of this year dealt a heavy blow to the Ruffer Investment Company, given this view, but its manager Russell was unmoved. He told FE Trustnet earlier this year that QE would persist regardless of the Fed’s murmurings.
His comments appear to have already been vindicated: the Fed has now backtracked on its plans, and the vast majority of industry commentators believe that QE in the US will carry on unchanged until at least April 2014.
Ben Willis, head of research at Whitechurch, thinks this change in attitude adds weight to Ruffer’s argument and as a result thinks it may be time to start preparing for an inflationary outcome.
"It’s not necessarily inflation today we have to worry about, but inflation tomorrow," he said.
"I can understand Ruffer’s argument, and I think it makes a lot of sense. Central governments’ priority is to reduce the debt burden, while deflation is something they want to avoid at all costs."
"It’s clear they have no plans to raise interest rates any time soon, so inflation does look like a possibility, and something they would rather happen than other scenarios."
"It’s very difficult to predict exactly when it will happen, but it does feel like there is a store of inflation that has been built up. They’ve extended the debt ceiling and QE has been given the green light again, so that store is growing and growing."
Willis says that he uses inflation-hedging strategies across Whitechurch’s balanced and cautious portfolios to counteract this risk.
"We’re pragmatic – a lot of the inflation hedges come from equities but obviously that’s not the only reason why we invest in them," he said.
"We also hold some inflation-linked bonds through the M&G fund, which aims to outperform a number of inflationary outcomes. Beating RPI is its priority, so that’s a good one to have."
The £346m M&G Index Linked Bond fund is headed up by Mike Riddell and Jim Leaviss, and invests almost entirely in UK Government bonds. It has consistently outperformed its IMA UK Index Linked sector average in recent years.
Performance of fund and sector over 1yr
Source: FE Analytics
The fund is rated highly by the FE Research team and is included in the FE Select 100. It requires a minimum investment of £500 and has ongoing charges of just 0.66 per cent.
While Willis likes the concept of inflation linked bonds, he feels they are very expensive, demonstrated by their significant correction at the very mention of QE tapering in May and June of this year. He is also wary of gold, which he sees as a purely speculative play.
"If anything, there seems to be more of a relationship with the US dollar than inflation," he said.
Mark Dampier, head of research at Hargreaves Lansdown, agrees that inflation is likely to rear its head in the foreseeable future, but thinks it is impossible to forecast exactly when.
For this reason, he thinks it makes sense to hold an inflation-focused fund as an insurance policy against this risk.
"I’m not clever enough to say exactly when it will happen, but I have a lot of respect for the people who are arguing for it," he explained.
"As well as Ruffer, it’s something that William Littlewood believes will happen as well. The problem is that a lot of these managers have cried out inflation, but because it hasn’t happened yet, people are now ignoring them. History tells us that doing that is dangerous."
"Littlewood refers to what happened in Japan in 1931, believing something similar is occurring today."
"After three or four years of huge stimulus, Japan withdrew at a time when there was little inflation. The prime minister at the time was actually assassinated for doing this, because a lot of the spending was on the military, which didn’t take kindly to the cuts."
"Eventually the policy led to inflation of over 500 per cent in Japan. How much the war influenced inflation is a matter of debate, but it’s an interesting parallel to draw."
Dampier points out that a lot of the money that has come from QE is still in the banks and so hasn’t got into the economy yet.
"Capital ratio requirements on banks are still going up because they are not lending – from what I hear, it’s the VCTs that are supporting SMEs [small-to-medium sized businesses], not the banks," he said.
"At the moment, there’s a blockage in the pipe, but when that blockage is removed, I think we’re looking at a huge credit cycle."
The Ruffer Investment Company uses a number of tools to combat inflation, principally through inflation-linked bonds – which have a 27 per cent weighting in the portfolio – and gold and gold equities.
Both of these overweight positions have hurt the trust at certain points this year, but Russell and co-manager Hamish Baillie’s significant exposure to Japanese equities has helped cancel out some of these losses.
Performance of trust and sector over 1yr
Source: FE Analytics
The fund is still behind its IT Global Growth sector average over the period, though management is keen to point out that the trust doesn’t have a benchmark and prioritises capital preservation above all else.
The Ruffer Investment Company has returned 149.5 per cent since its launch in July 2004. It has a particularly good record in falling markets, and was one of the very few trusts that made money in 2008, for example.
However, its inability to make the most of fast-rising markets means it has also slightly underperformed.
Performance of trust and sector since launch
Source: FE Analytics
The £345m trust is on a premium of 3 per cent and has an annual management charge (AMC) of 1 per cent. It doesn’t have a performance fee.
Russell previously told FE Trustnet that he expects negative real interest rates to result in an equity income bubble, which he believes is already starting to gather momentum.
Later today FE Trustnet will carry the most recent comments from Russell and Baillie on the markets and how they are adjusting the positioning of their fund accordingly.
