Achieving positive returns in a defined contribution (DC) investment portfolio, whatever happens in financial markets, means finding and owning assets which respond differently to changes in the investment environment. Crucially, it also means owning assets which respond differently to each other.
Whereas conventional bonds formerly protected clients against falls in equity markets, ankle-high interest rates have suppressed their protective power. We witnessed this recently in March 2020, September 2021, and April 2022, when equity and bond markets fell in tandem.
This year, other traditional ‘safe havens’ have also failed to provide the shelter DC investors might have expected. The yen has suffered even as equity markets sold off. And gold, despite inflation reaching 40 year highs, has been lacklustre.
All asset classes have been dancing to the same tune. And so far this year, it has been a dreary melody.
We’ve been wary of the absence of available offsets for some time. This led us to develop more creative protection strategies, and to invest in more unconventional assets.
In practice, this has meant incorporating derivative strategies into the portfolio. We seek protection that is both effective and attractively valued – instruments which offer convex pay offs.
All asset classes have been dancing to the same tune. And so far this year, it has been a dreary melody.
One example of this uncorrelated investment protection is our use of payer swaptions. We retain conviction in the power of inflation-linked bonds to retain value in an environment of financial repression. But these instruments rise materially only when there is a shift in inflation expectations – until then, the inflation-linked bonds carry significant interest-risk (as with conventional bonds). As central banks have embarked on their hiking cycle, payer swaptions have worked to offset the falls in fixed income and removed the need for us to perfectly time an exit, and re-entry, into the asset class.
Opportunistically, credit default swaps enable us to take tactical and targeted short positions within credit markets. As liquidity is sucked out of financial markets, these instruments provide a rare and unique means to make material returns in an environment in which the vast majority of assets could buckle under selling pressure.
At Ruffer, we have a strategy with the means and licence to invest in all corners of the investment universe. That means we can find uncorrelated assets, and ultimately, deliver uncorrelated returns.
Sources: Ruffer, Bloomberg. Chart: Proportion of variation explained by first two principal components. 45 years of weekly data across US, UK, Germany, Japan and EM equities, dollar index, GBP, EUR, JPY, AUD, oil, gold, commodities index, US and UK 10y yields. Data to April 2022
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