Positioning early for the next stages of the market cycle may result in some short-term pain but will protect portfolios in the longer term, according to veteran investor Jonathan Ruffer.
Ruffer, chairman of Ruffer LLP, said it has already begun to prepare its portfolios for the next three stages of the market which has had an impact on performance.
He said: “The performance of the portfolios remains becalmed, but it is the unseen currents in the water which will prove more important in vindicating – or otherwise – the stance that we are taking.
“If the markets are benign from here, then we believe that we’ll make good money. If there is a long–awaited setback, we think that the portfolios are well protected. If the subsequent landscape is arid and unrecognisable, we have, crucially, preserved flexibility.”
Ruffer added: “This last point is an important one. It is no good having the only hotel left standing in a battle zone, if the last visitor has gone for good.”
For the first phase of the market, the manager has positioned the portfolios 40 per cent to equities – its ‘middle range’ for the past few years – although its exposure is “emphatically not defensive”.
Ruffer said its equity allocation was concentrated in sectors that have not performed well more recently, such as: cyclicals, financials and natural resources stocks.
Performance of sectors over 5yrs
Source: FE Analytics
“Whilst it is true that the growth stocks have stolen the show in terms of investment performance, it has not been the only place to be, and the stock picking of our 30-strong research team has proved this,” he explained.
“We are positioned in the areas where strong economic growth should flow through to companies whose business models are robust.”
The veteran investor said if it did not think equity markets had anything to offer they would have a minimal exposure.
However, he warned that these stocks could go down “if the market breaks”, although other positions would protect the portfolio.
“The key is that this asset class could make a double–digit return if the sun stays out,” he said.
Yet, Ruffer warned that these markets “will at some point become dislocative, and when they do, the down pressure will be instantaneous”.
As such, the Ruffer chairman said it does not have a set view of what damage a comprehensive fall would do to his portfolios.
“We approach this the other way around,” he explained. “If the markets fall 30 per cent, could our portfolios withstand it? If they fell 50 per cent, could our portfolios withstand it?”
In both scenarios there are few asset classes that would protect portfolios completely, and as such it has invested small sums in instrument such as options and credit default swaps which could make money but will expire worthless until such a sell-off appears.
“This has cost the portfolios around 2 per cent per annum in the last few years – we emphasise that this is not a routine; it is a temporary response to the combination of asset prices being too high and interest rates too low,” said Ruffer.
“Our primary role is to ensure that we do not preside over a permanent destruction of a significant part of clients’ wealth.”
Already twice this century asset prices – between 2000-2002 and 2008-2009 – have halved and while they have bounced back, he said “these quick recoveries were the exception, not the rule”.
Performance of markets over 20yrs
Source: FE Analytics
Yet, Ruffer said that there is one asset class that falls outside of the breakeven during a crisis, long-dated UK index-linked stock gilts which make up around 10 per cent of its portfolios.
“The reason for this is that their price is extremely sensitive to changes in the level of real interest rates. In the maelstrom of dislocative markets, it is a bold statement to assert that this volatile asset class will be immune from sharp losses,” he said.
“We are nevertheless reluctant to reduce these holdings, because they represent a near-perfect vehicle to protect clients against low interest rates which – after tax – fall well short of compensating the holders from the losses caused by a future inflation.
“There is a chance that they will do well from the outset of market trouble. If we’ve sold with a view to buying back more cheaply, we will have lost this protection.”
The biggest danger for a third phase in the aftermath of a step-change in markets, Ruffer said, is the inflexibility of trading out of positions that are no longer appropriate.
He said: “These are the moments where cash is the engine of portfolios, since it is available immediately to reshape the assets.
“If portfolios have cash in this third phase of the market, there will be real opportunities for bargains, but only to those whose spending power remains intact.”
Ruffer said while it has taken action to protect its portfolios, there may still be some time to run for the current phase of the market.
“If the progression of events were static, these ‘long periods of time’ would make for nervousness,” he noted.
“The 2008 crisis centred on the excessive amount of debt which was manifestly represented by dud collateral.
“World debt got to 280 per cent of world GDP. That debt has changed shape over the last 10 years, but it hasn’t gone away. It is now 320 per cent and is still, relentlessly, rising.”
However, debt can also be ‘good’ helping economies grow and – when readily available at low cost – also helps assets grow, said Ruffer.
The firm’s flagship £5.4bn LF Ruffer Absolute Return fund – co-managed by FE Alpha Managers Steve Russell and David Ballance – aims to deliver low volatility and positive returns in all market conditions by investing in a range of assets.
Performance of fund over 5yrs
Source: FE Analytics
Over five years, the fund has delivered a total return of 21.33 per cent. It has an ongoing charges figure (OCF) of 1.15 per cent.