Jonathan Ruffer says his firm is staying clear of 'hairy monsters' in a 'perverse' period for investment.
In a quarterly update, Ruffer highlighted that the dominant force in investment right now is the distortion of the price of money.
He noted that with cash yielding next to nothing, this has left all assets overpriced, since they are priced against the return on cash.
'For the conservative investor, it also means that the more stable the investment opportunity, the more influenced its valuation will be by the yield on cash, which is off-the-scale expensive,' Ruffer said.
'We are therefore in the topsy-turvy world that the more inherently safe an investment is - a promise from HM government to pay interest and give your capital back in a year’s time, say - the more risky it is, because it is wrongly priced, and its very stability allows for no pleasant surprises in the actuality of the outcome.
'Perversely, the safest valuations are found in out-and-out speculations, since they have little correlation with the price of cash - but who wants to build a portfolio of hairy monsters? We certainly don’t!'
As a consequence, equity market staples - such as tobacco and food companies - are not found within the firm's portfolios, which include the Ruffer Investment Company (RIC).
Overall Ruffer has a lowish exposure of around 40% in equities, with three main emphases: a bias to Japan (where it views banks as 'incredibly cheap), special situations across the major economies and a high exposure to financials, specifically banks and insurance companies.
'In the event of a dislocative fall in the markets, these would not do well, but there is a possibility that after ten years of anaemia, the world sees a burst of coordinated real growth, without, for the moment, any inflation,' Ruffer said.
'The financials are not priced for this at all, and could be expected to be very strong. Their virtue will be to protect the portfolios from assets which would fall in this eventuality.'
The firm has virtually no exposure to conventional fixed interest markets, which is where Ruffer believes the 'epicentre' of the danger lies.
The heart of the portfolio
The portfolios' biggest conviction - index linkers - has been well documented over recent years.
The majority of this is held in the UK, mostly in short-dated stock, designed to be stable but provide 'a useful "extra" if our long and strongly held view that there will be inflation comes about', Ruffer said.
A large chunk of the portfolio is in ultra-long linkers however, which Ruffer notes are extremely price-sensitive to the yield environment.
'We could see extreme circumstances where they lose the majority of their value (circumstances which would drive the financials up by an equivalent amount), or multiply by around 30 times (the Wedgie world),' Ruffer said.
'Our philosophy is to examine all the possible outcomes and have as many "plays" on different outcomes as possible.'
This explains the firm's sizeable position in financials.
'The financials are there in size to protect us from being "wrong" on the inflation call,' Ruffer (pictured below) added.
'I put the ‘wrong’ in inverted commas, because it is perfectly possible
that it will be the onset of deep deflationary conditions which causes governments and central banks to do those things that hasten a long period of high inflation.'
Ruffer's biggest fear is if all asset classes fall in value, effectively killing the benefits of diversification.
'Historically, our protection in difficult times has been a diversity of assets. If equities and conventional fixed interest fell heavily together, would we be protected? This investment review casts a jaundiced view over the "cake and eat it" diversification.
'Yet without proper diversification we will not be well off, and many people are invested at Ruffer [the firm] to keep them safe through thick and thin.
'It will be no defence to say that we were too thick to have contemplated how universally ‘thick and thin’ might need to be interpreted. So, we too have our diversifications for this scenario.'