Ruffer has warned shifting monetary policy could prompt a run on bond funds and has positioned its portfolio to benefit, according to the half-yearly report for its £396.3m investment company.
The team reduced risk and increased protections over the six-month period to 31 December 2018.
“The volatility shock of February demonstrated that traditional safe havens cannot be relied upon in the next crisis; thus our protections have necessarily included investments designed to benefit from disruptions in credit markets and spikes in volatility.”
However, the investment company’s net asset value fell 5.08% over the period. The team said there was “no excuse” for the poor performance, particularly given the strategy’s objective to perform in both good and bad markets.
Credit markets are the ‘epicentre of risk’
The investment outlook in the closed-ended fund’s half-yearly report states credit markets are likely to be the “epicentre of risk”.
“They have experienced enormous inflows as a result of quantitative easing and zero interest rates, and now liquidity conditions have reversed. The combination of a potential run on bond funds and the possibility that investors might be attracted by the higher nominal interest rates in governments bonds provides the context for a bumpy ride in fixed income markets as monetary accommodation continues to be drawn away.”
Selling pressure would migrate to equities, one of the most liquid areas of capital markets, according to the outlook, which was attributed to Ruffer AIFM Limited.
“We retain our conviction that the protections within the illiquid strategies portion of the company’s portfolio will increase many times in value if the stresses observed begin to manifest themselves more seriously. As mentioned above, perhaps we saw the beginning of this in the last few months of 2018.”
Government index-linked bonds and equities accounted for the bulk of the portfolio the period ended 31 December 2018, representing 45.24% and 33.62% respectively, with the remaining in funds, gold and options. The Ruffer Illiquid Multi Strategies Fund 2015 accounts for the majority of the funds allocation, while the 1.73% options weighting is held entirely in the Ruffer Protection Strategies International.
In the six months to the end of 2018, the Ruffer Illiquid Strategies funds were the only contributors to performance adding 0.6% to the net asset value alongside the US dollar, which contributed 0.3% to the NAV. The Ruffer Illiquid Multi-Strategies Fund 2015 was up 30% in Q4 2018.
“It is encouraging that towards the end of the year, when the sell-off in markets intensified, our protective assets started to kick in. A deterioration in markets from here should see the company perform well,” the half-yearly report said.
Central banks have kicked the can down the road
Willis Owen head of personal investing Adrian Lowcock said it is not the first time concerns about runs on bond funds have been raised due to shifting monetary policy, although he did not expect a run in the current calendar year.
“There are lots of companies who have borrowed cheaply and when interest rates rise it is only then that you see which of the boats (companies) had leaks in them and were not of good quality. There is a risk that not only do you get a slate of downgrades but also you get investors fleeing for the more quality areas of the market causing a sell-off of the less savory investments.”
Lowcock said a rotation into government bonds had yet to take hold due to their interest rate sensitivity.
“However, as interest rates reach a peak then government bonds will look attractive especially if there are concerns over the economy. But it needs a stimulus or trigger that will force investors to take less risk and less return. For a run on bonds that trigger might well need to be significant – a US recession for example might be the trigger – but currently it looks like that will be avoided in 2019 at least.”
Tilney managing director Jason Hollands said the can had effectively been kicked down the road when it came to fixed income volatility as monetary policy remains highly accommodative. “The Fed has effectively put further rate rises on hold. Real interest rates remain negative in the eurozone and with Germany teetering on the edge of recession, it is hard to see aggressive tightening in European any time soon.”
He added that it made sense for the Ruffer Investment Company to focus on a run on bonds as a potential risk given its high emphasis on capital preservation.