Seeking consistent positive returns.
Come rain or shine.
In December, I couldn’t stop thinking about that volcano in Iceland – it has the usual unpronounceable name – which blew its top shortly after this Review was written.
The unfortunate villagers who lived on top of it had been evacuated; but what was expected to erupt within hours was then demoted to ‘within weeks’. I remember a vulcanologist telling me that a call within 80 years of the actual event was regarded in that milieu as being ‘right’. I therefore look on them with respect, but also a certain envy, since we investment gurus are given no such leeway.
I am writing this after a ‘down’ year; we resist the strong inclination to blame the investments themselves, rather than our choice of them. Why did it happen? Too many of the things which were meant to go down went up, and a few – only a few – of the things that were meant to go up went down. It is worth reminding both clients and ourselves what our performance aspirations are: never to have a down year, and to make sufficient to justify the opportunity cost. With interest rates at 5%, to say nothing of inflation, there’s quite a shortfall at Ruffer over the last 12 months. This pains us, but our long-term performance remains good, and competitive with much riskier assets such as equities which have, over the 30 years since we started, been the best major asset class as regards total return.
If all the markets were a stage, and all the players in it were supermen and women, then there would be no opportunity to make money by trying to garner a return from wrong odds offered in the marketplace. An all-knowing mind would remove all opportunities. But luckily, the actual players are mere men and women (and now machines), and that creates opportunities. A single example will suffice: our dominant thought at the beginning of the year was – and remains – that inflation will ultimately prove to be a semi-permanent condition in the Western world. We therefore retained our long-dated inflation-linked bonds, which are a double-numbered domino: as well as having an inflation protection (which we wanted), they are also a conventional bond with many years’ maturity (which we didn’t really want). We therefore juxtaposed the linkers with short positions on the stock of companies with strong growth prospects – companies which, incidentally, we often admired.
Of all the horsemen of the apocalypse, the least predictable is liquidity, because a liquidity crisis is one that can be cured – for a while, anyway – by the foresight of central banks and governments.
There is risk in this approach, of course. The sharp rise in interest rates makes the future earnings of growth stocks less valuable. The key is that it does so mechanically – future earnings become less valuable (not merely arguably less valuable) when they are discounted at the higher rate of interest; the company’s worth becomes actually, actuarially, less than it was. Prices, and therefore performance, however, are not determined by what something is mechanically worth, but by the prices established by mere men and women (and now machines). Our judgement was that whether interest rates were higher or less high than expected, having money on both these red and black plays on the roulette wheel would have elicited a positive return. I have spent a lifetime looking for the opportunities created by juxtaposing investments which benefit and those which suffer from the same impulse. It has served clients well in the past, and it will continue to do so in the future – of that I am confident. In 2023, though, it caught us out: the ‘actuarial values’ were not always the same as the market value – and that’s the judgement seat of investment performance.
Were the mortals and the algorithms acting perversely, thereby excusing our judgement in making a wrong call? Alas, no. We entered the year concerned there was going to be a liquidity crisis. There wasn’t – in fact there was a floodtide of it. Of all the horsemen of the apocalypse, the least predictable is liquidity, because a liquidity crisis is one that can be cured – for a while, anyway – by the foresight of central banks and governments. Foresight is exactly what the US Treasury had this year, switching from the issuance of long-term Treasury bonds to short-term bills, which did the trick. The cynical view that one can rely on central bankers and governments to get it wrong is often correct, but not in 2023.
What of markets today? The central elephant roaming the carpet is the optimism with which the market greeted the relentless fall in interest rates, beginning on 10 August 1982, the day I got engaged, and continuing these last 40 years. The bull market in bonds probably died in November 2021 when interest rates reversed their decline and headed upwards, but in its death throes it is still kicking. We are in the treacherous open sea where the waters of two oceans meet: the rules learnt, polished and ossified over 40 years of ‘more of the same’ meet the examiner’s addendum question, ‘Would your answer be different if…?’ Markets may be wrong, but they are rarely perverse.
As we look forward to 2024, we see a world which is curiously unfit for investment purpose. The extraordinarily long bull market in equities has not prepared investors for the two-way battles ahead. Equities are pretty universally regarded as the premier investment – something which has been true for less than my lifetime, which began in 1951. Before that, equities were commensurate with ownership – if you wanted or needed control of a business, then of course the equity mattered. But a minority holding of a company controlled by others made you the rabbit – someone else’s lunch. This unfortunate truth has been masked by the fact that the true controllers of a corporation – its senior management – have learnt the trick of monetising that power by creating stock options. Existing shareholders, who would otherwise resent this dilution of wealth, are placated by the arithmetic advantages of leveraging the business, not least by buying back shares which erode the core capital of the business but increase its per-share earning power. An all-seeing market evaluation might applaud the increase in earnings per share, but it would also deplore their quality, and attribute a lower valuation multiple to those earnings.
There’s another worrisome trend. Most interesting newcomers no longer seek a public quotation – they go to the more informal, less regulated private equity and private debt markets. The indices themselves have become, especially in the United States, unrepresentative of the generality of quoted investments, being dominated there by the ‘magnificent seven’, which are in parallel to an earlier iteration of the magnificent seven (those Seven Sisters happened to be oil companies). Where is the accident waiting to happen here? The answer is the many holders of ETFs, who are unaware that the outperformance of the S&P is the direct result of such purchases made with the explicit intention of being indifferent to the underlying structure of their investment. Defending the investment management industry requires almost the same pirouette as being kind about central bankers. But when time is up for the magnificent seven, the ragbag of the rest of the quoted sector will outperform the tech-dominated indices – and the causation of that phenomenon will be as removed from their innate talent as its previous underperformance.
The question of debt levels is an area of concern, too, in the balance sheets of national accounts. It is an old truth that ordinary people are immediately punished for non-payment of small sums of money, whereas those with more substance can go for longer, eventually succumbing to a more egregious indebtedness. The levels of debt in government balance sheets are very high – unprecedentedly so outside wartime, a time when draconian laws ensure universal cooperation. The longest delay between the taking on of unsustainable debts and the eventual effective bankruptcy probably belonged to the Spanish Habsburgs, where disaster was delayed for around 125 years. A similar revulsion today – a very different thing from the US politicising of the debt ceiling – would appear as a most unexpected shock. But the seeds of such a crisis are already sown; it is a when, not an if.
Whilst our style of investment is therefore to have as our prime view that surprises will come on the downside, it emphatically does not mean that if markets remain firm, the investment stance of our portfolios will, ipso facto, be compromised. But we do require our offsets to be more robust than they were in 2023.
So I am coming to the conclusion that I am not as envious as I thought of those vulcanologists, with their 80 year horizons, uninterruptible as they may be by the chorus of “Why did you call it wrong?” We did indeed get it wrong last year, but it has made us look afresh at what we are doing, and it has reminded us, too, as to why we are doing it. This is not an intellectual exercise, it’s a battleground, and we fight these enemies of uncertainty on behalf of our clients – that’s what it is to work in a service industry.
Past performance is not a guide to future performance. The value of the shares and the income from them can go down as well as up and you may not get back the full amount originally invested. The value of overseas investments will be influenced by the rate of exchange.
The views expressed in this article are not intended as an offer or solicitation for the purchase or sale of any investment or financial instrument, including interests in any of Ruffer’s funds. The information contained in the article is fact based and does not constitute investment research, investment advice or a personal recommendation, and should not be used as the basis for any investment decision. References to specific securities are included for the purposes of illustration only and should not be construed as a recommendation to buy or sell these securities. This article does not take account of any potential investor’s investment objectives, particular needs or financial situation. This article reflects Ruffer’s opinions at the date of publication only, the opinions are subject to change without notice and Ruffer shall bear no responsibility for the opinions offered. Read the full disclaimer