Jurassic risk

And the chomping of the traditional balanced portfolio
Ruffer Review
Henry Maxey
Henry Maxey
Chief Investment Officer

The death of inflation has been greatly exaggerated. Its return – perhaps as 1970s-style T-Rex or 2020s genetically-mutated velociraptor – will first scare, then maim, then ruin the traditional balanced portfolios that have served investors well for a generation. Investors need to prepare for a world of greater inflation volatility. And with it a Jurassic risk – bonds and equities falling in tandem.

A great fear stalks the land of asset management – the return of inflation. And, with it, the death of an investing paradigm: the dominance of a traditional balanced portfolio of 60% equities, 40% bonds. These 60:40 portfolios have been structured to provide a good level of long-term returns, but with a smooth ride. They have been a successful construct, as Figure 1 shows.

Ruffer Review

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Today, with bond yields now so low and inflation fears creeping in, investors are confronting the obvious concern. It is summed up well in this quote from Eric Peters of One River Asset Management: “The unprecedented policy response to the pandemic has forced investors to now build portfolios of risk assets without being able to rely on Treasury bonds to materially offset the negative convexity. Consequently, the industry now faces an acute shortage of portfolio diversifiers at a time when it must take ever more risk to achieve its return targets. And the unintended consequences are as profound as they are not yet fully appreciated, let alone understood.”

In short, are bonds still the low-risk, diversifying assets which their historical statistical characteristics suggest they are? And, if you’re feeling really jolly, you should re-examine the role of equities too. Shareholders are benefiting from receiving a historically-high proportion of stakeholders’ return. What’s more, that return to shareholders is being capitalised on very low interest rates.1 Both of these supports would probably be tested in an era of higher inflation. They will be further tested if, as seems likely, the political economy is tilted towards redistribution of wealth and income (resulting in lower margins).

As we saw in the 1970s, inflation is the beast that will eat your 60:40 portfolio (and eviscerate your risk-parity portfolio too). Anyone running a traditional asset allocation for their clients should rightly fear it. Yet, as Jamie Dannhauser covers later in this year’s Review, inflation itself has felt such an unrealistic prospect because of the structural disinflationary forces that have surrounded us for the past 40 years.

We can all imagine the terror of facing a T-Rex. But the thought doesn’t linger for more than a microsecond because, well, they’re extinct. So too, apparently, inflation...



Ruffer Review 2021
Download our 2021 edition of the Ruffer Review. In it we explore the fate of traditional balanced portfolios, our latest big picture thinking – on regime change and inflation – as well as fresh perspectives on trust, belief and behavioural bias.
Dismantling the deflation machine
Seeking to escape the inflation of the 1970s, policymakers have inadvertently engineered an equally powerful deflation machine.
A bias to belief
February 2021: Bethany McLean joins us to discuss the tension between rational markets and emotional investors, what separates the visionary leader from the fraudster and how a bias to belief affects our decision-making.
  1. The stock market is expensively rated. But, if today’s interest rates and credit spreads are here to stay, then it is possible to argue the market is fairly valued.

Figure 1: Global Financial Data, Ruffer. Based on a logarithmic scale

This article was originally published in the Ruffer Review 2021.

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