Ruffer Investment Company’s inflation protection strategy wobbled in January, with the anticipation of rising US rates creating a difficult backdrop for its inflation-linked bonds.
The company increased its weighting to the longest dated inflation-linked bonds in the UK in November, on the belief that central banks will be unsuccessful in keeping a handle on rising inflation.
“These options remain a key portfolio component,” said managers Hamish Baillie (pictured) and Duncan MacInnes in their latest investment update. “And allow us to manage the company’s interest rate sensitivity in what we expect will be a volatile period for bond markets.”
The company’s NAV rose by 0.8% in January, markedly better than the FTSE All-Share index which fell 0.3%.
The US was a central focus of the update, with Baillie and MacInnes saying “there are signs that higher inflation is embedding itself across the US economy, notably the labour market, and will not necessarily ease once supply chain disruptions abate”.
“With interest rates close to zero and consumer price inflation at 7%, US policymakers are reacting to the realisation that conditions have been too accommodative for too long.
“Current expectations see four rate hikes in 2022, up from two at the turn of the year. Investors are forced to adapt to a world where the Fed now shows greater willingness to withstand financial market volatility in combatting inflation.”
Greater correlation between bonds and equities
In terms of global equities, the duo said they “offered little respite”, recording their worst monthly return of -4.5% since March 2020.
“The declines were even greater for the technology-focused Nasdaq composite (-9%), confirming our fears that the faster growing and more speculative parts of the equity market would be most acutely impacted by a rising cost of capital.”
Baillie and MacInnes added that “growing geopolitical tensions emanating from Russia and Ukraine did little to improve risk appetite”.
“On a historical basis, inflation above 3% sees the correlation between bonds and equities turn positive and January provided a brief taste of the challenges conventional portfolios will encounter as monetary conditions tighten.”
Pockets of resilience
More cyclically exposed equities, which have been out of favour for most of the last decade “returned to prominence”, said Baillie and MacInnes. Proving that there “were pockets of resilience”.
“Our equities, which are heavily tilted to this part of the market, contributed a positive return over the month. The most significant drivers of performance were the energy majors, which continued to rally as oil prices reached a seven-year high. Demand remains strong and supply constrained, supporting our continued exposure across the energy sector.
“Elsewhere, bank stocks benefited from the rise in yields, supporting their position as an offset to the inflation-linked bonds. We resisted the urge to add meaningfully to equities during the recent weakness and instead maintain the current exposure at just below 40%.”