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Ruffer ups protection as 'treacherous' bond accident fears grow

Ruffer ups protection as 'treacherous' bond accident fears grow

Ruffer stayed cautious in January as investors piled back into equities as its fears over contagion from an 'accident' in corporate bonds grew.  

The Ruffer Investment Company's managers, Hamish Baillie, Steve Russell and Duncan MacInnes, expressed concern about the complacency being displayed after markets recouped some of their losses in January, following the severe volatility in the fourth quarter. 

'The principal reason [for the recovery] was not hard to find: soothing words from Jerome Powell, chair of the US Federal Reserve, concerning the future path of US interest rates and the shrinkage of the Fed’s balance sheet, both of which had been key factors in December’s sell off,' the trio said in their monthly update.

With investors sensing that the US central bank was back on their side, it came as no surprise to Ruffer that equity markets rallied sharply.

However, those who believe rate rises are off the cards for now could be in for a surprise, the team warned. 

'We are more than a little concerned that the above development has made investors complacent and increased the Fed’s dilemmas going forward,' they said. 

'Markets have now priced out any rises in US interest rates this year, even though US jobs growth remains strong, unemployment is at 40-year lows and US wage growth above 3%.

'If such trends continue, interest rate rises will be back on the table, and the confidence of last month could evaporate rapidly. If, on the other hand, the Fed stands pat in such circumstances, the risk of inflation seeping back into the system will grow, and it will be deemed to be behind the curve and to have lost control of policy.' 

Baillie, Russell and MacInnes added that they have 'no grouse' with the view that equities could rally further.

While they admit it has been 'pleasing' to see several of the portfolio's cyclical stocks rally, they had no intention of increasing exposure to risk assets.

'We are loath to raise further the portfolio’s exposure to equities,' they said. 

Bond accident 

The managers were also concerned about the recovery in credit in January given the 'continuing degradation' in lending standards and the lack of risk premium being offered to buyers of corporate bonds. 

'Today, 50% of outstanding investment grade credit is rated BBB,
(one notch above junk status), whilst the underlying corporates have higher leverage and the loan documents fewer protective covenants than at the peak of the last cycle,' they noted. 

The team was not surprised that its credit protections lost ground in January, giving back some of the near 30% gain made during the fourth quarter volatility.

However, it saw this as an opportunity to reinforce these positions. 

'This reflects our belief that the area of credit remains the most treacherous part of the financial system,' the team explained. 

'With liquidity in this market a shadow of its former self, we believe any accident in corporate bonds could rapidly spread to other risk assets, further supporting our relatively cautious stance.' 

This cautious stance is typical of the entrenched philosophy the various managers of the £385 million trust have employed over the years.

Over the last five years the Ruffer trust has returned a total 5.9% to shareholders. The portfolio net asset value fell 3.5% in 2018, and the shares have slid to a 3.5% discount. 

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