The Ugly Duckling portfolio

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19 July 2024

The Ugly Duckling is a Hans Christian Andersen fairy tale from 1843 about a duck who was born different. He was teased and rejected by the other ducks because he didn’t look like them. He sees a different world to other ducks – and he couldn’t bring himself to join the flock.

Ruffer’s portfolio today feels a little like the ugly duckling full of deeply unloved, beaten up and lowly valued positions. Many of our assets have already been shunned, jeered, and cast out into the wilderness by investors.

Our ugly ducklings are positions that other investors either can’t or won’t hold. The skill is to try and blend them together in a portfolio which we can hold onto until the market turns.

We think that each of these ugly duckling positions has the potential to mature into a beautiful swan and a portfolio full of these ducklings offers a really attractive differentiated return stream. Moving on to take a look at the flock of ugly ducklings, you may wish to adopt a single one, or consider buying the whole flock.

UK equities

The Labour Party’s 1997 election theme song, ‘Things Can Only Get Better’, feels like a timely nod to the UK, for so long the ugly duckling at the global equity party. Unlike the rest of the world, the UK now looks politically settled, and the consumer is feeling perky having weathered covid and the cost-of-living crisis.

The UK stock market is cheap but has been so for many years. So what’s different now? We might be running out of sellers, outflows have been relentless for almost the entire period since Brexit. Pension funds and wealth managers have record low levels of exposure. New bidders are emerging. In the first six months of 2024, 32 takeovers were announced and the bid premium is averaging 30% and the quantum is a threefold increase since last year.

Gold equities

The reasons why gold is going up are clear – geopolitical concerns, inflation worries, fiscal incontinence, perhaps a desire to avoid the tax man. But gold stocks, until recently, were completely ignoring the gold price. Since 2010 gold has almost doubled and the gold mining stocks are down 40%.

There are many good reasons investors shun the equities – the rise of sustainable funds, spendthrift management teams, historically bad capital allocation policies including bad mergers – but arguably it has gone too far, and these issues are mostly in the rear-view mirror. Newmont – the biggest, blue chip stock trades on an 11% FCF yield at $2,300 gold. Almost all of the smaller players in the sector are cheaper.

Earnings revisions in the sector are going to be spectacular – looking at the sell-side models nobody has $2,300 gold priced in. What if it goes to $3,000?

The yen

The yen is the cheapest major currency in the world. One would have to go back to December 1986 for the last time dollar/yen traded at 161. On a real effective exchange rate or purchasing power parity basis, it is also now testing multi-decade lows – we acknowledge this provides no clue on timing, but a strong hint on value.

The Bank of Japan has repeatedly intervened to prop up the currency, with some success so far, but their determination and need is growing. Anything which causes the yield gap to narrow further, from either side, should drive the yen up in value. With wage growth and inflation in Japan running at 30 year highs, we think it will be a combination of BOJ interest rate hikes and Fed rate cuts that work from here. Lastly, from a portfolio perspective we like the characteristics the yen brings to the table. It has historically functioned as a safe haven asset. In the financial crisis, yen denominated holdings doubled for sterling investors inside 12 months.

Volatility, equity put options and credit protections

The word to describe the current market environment is complacent. There remains much to worry about – the geopolitics and domestic political situations have turned chronic, recession and inflation risk are not yet vanquished, valuations remain high. Yet as we know, markets have rallied to all-time highs.

As a consequence of this implied certainty, portfolio hedges are nearly the cheapest and most asymmetric we have ever seen. Despite benefitting from booming markets recently, nobody wants to pay to protect their downside – especially if they think policymakers are doing it for them for free. VIX (a measure of equity volatility) and credit spreads are at pre-covid lows – suggesting a very benign or sanguine outlook. The cost of S&P 500 puts are on some metrics the cheapest we have seen in a decade.

China equities

Perhaps the ugliest duckling of all? ‘Un-investable’ is the knee-jerk response. We have some sympathy with that, but the bear case has become consensus, capital has been sucked out of China and moved towards the US bull market. These are some of the cheapest equities in the world.

What’s nice about this duckling is that if that bear case comes to pass – for example, Xi invades Taiwan – these stocks might be a zero, that is a catastrophic result for Chinese equities. We would also suggest it’s a pretty catastrophic result for the MSCI World and market darlings like TSMC and Nvidia too. But in that scenario – what is oil doing? Gold? S&P 500 downside protection? VIX? Bond yields? We think the protective side of our portfolio does extremely well in that scenario – the overall portfolio could well be up.

Summary

Looking forward, we are excited about our opportunity set. We believe investors are complacent and we have arguably never seen an equity market as crowded, narrow, and myopic as the one we see today. We think the prospective rewards, relative and absolute, for having a portfolio unlike both peers and benchmarks have never been higher. There is an old market aphorism that you make more money when things go from awful to just plain bad than you do when things go from good to great. The ducklings are maybe about to become swans, and it may happen faster than most of us can imagine.

GET IN TOUCH

Piers Wheeler

Director – Institutional

T +44 (0)20 7963 8258

Developing and executing asset management strategy for capital raising and strategic relationship management. Coverage includes EMEA, Asia and Australia. Piers joined Ruffer in 2021, having previously worked with asset management firms including Eastspring, AMP Capital and LEK as a strategic consultant. He holds a MA from the Bayes Business School and a BA (Hons) from the University of Oxford.

Annabel Paterson

Senior Associate – Institutional

T +44 (0)20 7963 8123

Joined Ruffer in 2021, having graduated with a first class honours degree in land economics from the University of Cambridge. After two years working with the UK Private Wealth team and completing her IMC and CFA Level I qualifications, she now supports Ruffer’s global business development and client servicing efforts.

Articles by Annabel

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. This financial promotion is issued by Ruffer LLP which is authorised and regulated by the Financial Conduct Authority in the UK and is registered as an investment adviser with the US Securities and Exchange Commission (SEC). Registration with the SEC does not imply a certain level of skill or training. © Ruffer LLP 2024. Registered in England with partnership No OC305288. 80 Victoria Street, London SW1E 5JL. For US institutional investors: securities offered through Ruffer LLC, Member FINRA. Ruffer LLC is doing business as Ruffer North America LLC in New York. Read the full disclaimer.

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London

Ruffer LLP
80 Victoria Street
London SW1E 5JL

Directions | Map +44 (0)20 7963 8100

Paris

Ruffer S.A.
103 boulevard Haussmann
75008 Paris, France

Directions | Map +33 (0)1 88 45 02 54

New York

Ruffer LLC
300 Park Avenue
New York NY 10022

Directions | Map +1 917 947 3003

Edinburgh

Ruffer LLP
31 Charlotte Square
Edinburgh EH2 4ET

Directions | Map +44 (0)131 202 1602

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The Ugly Duckling portfolio