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What you don’t own matters more than what you do

Will the market or economy break first under strain of higher rates?

2022 may well turn out to be the year when hedge funds came back into favour across investment markets. The confluence of events, which has seen the traditional negative correlation between long duration bonds and equities quickly turn positive, has had a significant impact on investment returns.

Thus far in 2022, UK-based Ruffer LLP, a UK founded investment management firm, is having success with its single-strategy approach. Little known outside of institutional circles, the group is likely more transparent than the traditional expectation of a “hedge fund,” but has managed to navigate 2022 with a positive return year-to-date; a rare result amid the worst period for the 60/40 portfolio in decades, and the worst for the US bond market since 1788 (before George Washington became President).

It is becoming evident that the days of the 60/40 portfolio as we know it are numbered, as investors facing more volatility in economic conditions and inflation are forced to react more quickly to changes in the market narrative.

  • “In any kind of bear market, it is what you don’t own that matters more than what you do own,” the group explained in a recent update on the strategy. With a single purpose of delivering consistent positive returns regardless of market conditions, Ruffer must be hyper-wary of under-appreciated risks.

    “Our avoidance not just of profitless tech, but also outrageously profitable (but expensive) tech,” has been central to the positive returns achieved from the group’s equities allocation in 2022, the firm says. The equity allocation remains at around 35 per cent of the portfolio, with the remainder in short or inflation-linked bonds (24 per cent) and gold bullion (10 per cent) and cash (6 per cent). Importantly using options to dynamically manage duration risk.

    Rather than sell-out entirely, the equity team has broadened the exposure on what it considers “value defensives,” a group spanning telecoms, healthcare and pharmaceuticals companies. The top holdings list includes the likes of Vodafone and GlaxoSmithKline among the top ten exposures. This and a current emphasis towards UK equities (14 per cent) which held ground in April, have been central to short-term outperformance. Interestingly, the UK equity market is playing-out much like Australia, with the sectoral composition including a bias to energy, miners and value, offering under-appreciated diversification. 

    Despite predicting the return of inflation for some time, the group is now more sanguine, saying “we now doubt the resolution of central banks to raise rates sufficiently far to choke it off. This means the key question right now is what will break first, the market or the economy?” it explains. 

    Ruffer believes the stock, bond and credit markets will snap first, hence the growing allocation to “protection” strategies that ultimately pay-out when the potential for credit defaults around the world increase, something expected in a recessionary environment.

    Concluding, the group says “the world has turned out to be more uncertain and more unpleasant than we expected at the start of the year,” but it feels that achieving its long-term goal remains possible. 

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