Ruffer Investment Company is designed to deliver steady all-weather returns across the cycle, aiming to protect capital in falling markets and deliver double the Bank of England base rate on a 12-month rolling basis. Primarily a long-only vehicle, the trust also uses currencies, derivatives and illiquid strategies as part of its highly differentiated investment process and is managed on a day-to-day basis by Steve Russell, Hamish Baillie and Duncan MacInnes.
The managers have believed for a long time that efforts to reflate the economy will result in too much inflation, which central banks will find hard to control, and the portfolio is designed to perform well in an inflationary environment, with significant exposure to UK and US index-linked treasuries. In the meantime, however, the managers are keen to ensure that investors are paid to wait; using equities – a mix of special situations, macro opportunities and value plays – to enhance performance.
2018 was a tough year for Ruffer, which lost 5.6% - more than it has lost in any calendar year since inception, and the trust’s performance as a result of recent declines now looks weak over one, three and five years. The trust has traded at a consistent premium since the referendum and its discount at the time of writing reflects this unusually poor showing – at nearly 5% this too stands at a level which hasn’t been seen since 2007.
The trust’s equity exposure – largely made up of cyclical and value stocks, a sharp fall in the oil price, and significant sterling exposure held in the view that more or less any positive news out of the Brexit fiasco would be better than the market’s expectations, all weighed on returns.
A difficult time recently, then, for shareholders in the trust. Yet closer examination of the trust’s NAV over the last twelve months shows that, as the sell-off has intensified, the portion of this trust’s assets which really differentiate it from its peers – and offer the greatest defensive qualities – came into their own. The trust’s protective assets, particularly its illiquid strategies, performed well; the Ruffer Illiquid Strategies Fund 2015, for example, appreciated by 30% over the last quarter of 2018.
It is worth noting that these defensive assets were put it in place to protect its shareholders against real, consequential, falls in the market - not to shield them from every bump in the road. Ruffer has seen difficult periods before, notably in 2006 when the trust struggled to keep its head above water as the initial cracks appeared before the financial crisis. With that in mind, while concerns about the health of the global economy continue to escalate, the managers believe there is comfort to be taken from the clear impact that these protective assets had on performance in Q4 when markets really began to tumble.
Ruffer has a long history of protecting capital during downturns, most dramatically during the 2008 financial crisis when it generated positive returns of 25% while the market lost 30%. Between downturns, the trust has generated consistent annualised returns in excess of 7% per annum since it was launched.
Last year saw the trust lost around 5% - more than it has lost in any year since inception. That this is remarkable is in our view testament to the manager's reliability with which they have navigated the turbulent sixteen years since the trust was launched. Far from heralding the end for this tried and tested strategy, the longer term track record would indicate that this will perhaps be a mere bump in the road.
We note that as the sell-off intensified in Q4 2018, the trust's capital protection assets began to deliver. The Ruffer Illiquid Strategies Fund 2015, for example, appreciated by 30% over the last three months. We are also encouraged that the trust's equity portfolio, largely made up of economically sensitive value stocks, is in a good position to potentially rally should markets bounce from here, while the protective assets will generate further returns if markets fall further. We think this is an enviable position, and remain confident that Ruffer is a solid choice for those seeking a wealth preservation vehicle for their portfolio which is capable of delivering inflation plus returns over the longer term.
|Having endured a difficult year, the portfolio is in a position where it could benefit regardless of which way the market moves next||The idea that QE will eventually stoke inflation is a key part of the managers' philosophy but inflation has, thus far, remained remarkably reluctant to rear its head|
|Should a significant correction occur, the trust's capital protection assets are likely to generate a significant boost for returns||The emphasis on preserving capital trust can feel a little leaden to investors when equities markets are buoyant|
|The trust is highly differentiated versus the competition, with few similar offerings on the market and even fewer with this track record|
Ruffer Investment Company is designed to deliver steady all-weather returns across the cycle, aiming to protect capital in falling markets and deliver double the Bank of England base rate on a twelve-month rolling basis.
A core tenet of the managers’ philosophy is the view that QE and efforts to stoke inflation will eventually result in too much inflation, which central banks will find hard to contain. The portfolio unashamedly reflects this – with more than 40% of the portfolio held in index linked bonds. Among the index-linked bonds, 12.4% of the portfolio is held in long-dated index-linked Gilts which the managers believe would perform very strongly in the event that inflation really kicks in, a scenario demonstrated by the chart below.
SNAPSHOT: THE CASE FOR LONG-LINKERS
Notes: If the real yield changes from -1.7% today to -5.6%, the price of this bond would move from £240 to £1,900 (a c660% increase). A shift of equal magnitude in the opposite direction, to a real yield of +2.4% would result in the price falling to £33 (a c90% fall). This exemplifies how the long-dated index-linked bonds have an asymmetric pay-off, particularly in an environment where higher inflation and low interest rates are likely to play a key role in clearing the real value of debt, currently at unsustainable levels. Source: Ruffer, Bloomberg, as at December 2018.
Gold makes up 8.8% of the portfolio. The managers switched out of gold bullion, toward which they had a significant exposure, into gold shares in the middle of last year which proved to be a timely move. Appetite for gold shares has picked up strongly and the managers saw one of their holdings – Randgold – rally 40% after the company merged with Barrick.
The trust’s equity exposure – which has fallen overall since we last spoke to the managers – is split largely between the UK (10.5%), Japan (10.4%) and North America (9.3%), with small weights also in Europe (2.9%) and Asia (1.5%). As we discussed in our previous note, Ruffer does not exist solely to act as a ‘doomsday’ fund which only performs well during market crises – it must also deliver returns between these periods. It was in pursuit of these returns that the managers last year favoured cyclical value stocks, often financials, many of them troubled businesses with correspondingly cheap valuations. They chose this route in light of what appeared to be a late cycle boom in the economy, which would have benefited the earnings of cyclical companies, and accompanied by higher interest rates should’ve been good news for financials. Their view on the economy, and interest rates, was proved correct – but investors aversion to risk saw value stocks savaged, undermining returns from this quarter. We note, however, that this leaves the managers in an enviable position at this point - with any sign of recovery likely to trigger a sharp rebound in these assets, and any further falls likely to stimulate more returns from the capital protection element of the portfolio.
Whilst the trust remains primarily a long-only vehicle, the managers have recently diversified their approach to include a growing exposure to options and illiquid strategies, which now make up 7% of the portfolio. In our previous note on this trust we saw that the trust’s use of VIX options was of significant benefit to the portfolio in February 2018 when the VIX index spiked. The managers have diversified into new instruments as volatility has increased and the VIX index has become more expensive. The derivatives book is now split between interest rate options designed to protect the index linked portfolio from rising nominal yields, and equity put-spreads which have largely replaced VIX options and protect the portfolio in the event of a material fall in markets.
It is important to note that these options are not meant to smooth out bumps in the road - indeed they would not be a cost efficient way to achieve this were this the aim. In the meantime there is a cost of carry to these options, which has a drag effect on performance, but as we saw in the closing stages of 2018 when market falls become severe their positive impact is clear, and the upside from this quarter grows should the market fall further.
The other element of this part of the portfolio is the trust’s exposure to illiquid strategies such as long dated volatility options and credit default swaps; the latter of which are particularly well placed in the event of a sell-off, when the most liquid assets are likely to be first in line for the chop for investors seeking safety.
Given the trust’s global approach, currency is an important factor. However, the managers' view is that, without a strong conviction the risks are too great to take an active position, given that shareholders' base currency is sterling and their belief that the UK currency will be a ‘lightning rod’ when the Brexit negotiations reach their conclusion. “It is very tempting to have a lot of money outside sterling at the moment,” says Hamish, “but newsflow around Brexit at the moment feels as bad as it could be, so even a slightly less disappointing outcome than expected could see a significant bounce – which would be painful if you were outside of that." That being said, there have been times in the past when the managers have held a strong view on currencies and have held a larger amount outside sterling.
Ruffer sits in the AIC Flexible Investment sector which is something of a catch-all, including funds like F&C Managed Portfolio, a fund of investment trusts, and Hansa Trust – which has 30% of its exposure in a single holding (a Brazilian port company). As such, comparison with the broader sector is of limited value. Instead we prefer to look at the trust alongside those which most closely resemble it in purpose; namely RIT Capital Partners and Personal Assets Trust.
All three trusts have highly experienced management teams – and all three have delivered consistent, low volatility returns over the long term. Personal Assets had delivered annualised returns of 6.66% over ten years, while RIT Cap has delivered 8.16%. Ruffer has returned 5.75% in annualised terms over the same period, but has by some margin the lowest maximum drawdown of the three.
The trust has the ability to gear but has never done so and, given its remit to protect capital, is unlikely to do so in the future.
For a trust with an absolute return mandate, last year was a tough one for Ruffer. The managers are very aware of this – to the extent that the latest investment review from chairman Jonathan Ruffer starts with an acknowledgement to disappointed investors, and an explanation of the house-view that underpins the trust’s positioning.
The trust’s equity exposure, though reduced overall as a proportion of the total portfolio, was the largest detriment to performance as the cyclical value stocks favoured by the managers were hammered by increasingly risk-phobic investors. Western equities, the previous year’s strongest contributor, cost 2.3% while Japanese equities contributed -1.5%. The cost of carry associated with the trust’s options also had a negative effect (-1.1%), but we note that this puts the trust in a good position at this point – with further falls in the market likely to benefit the capital protection element of the portfolio, and any bounce potentially magnified by the equity exposure.
In NAV terms the trust is down 4.5% over one year to 11 January 2019. On the other hand, over three years it has delivered 11.5% in total - slightly more than it has delivered over five years (11%) according to data from Morningstar. These returns look pedestrian relative to the equity indices over the same period, but that is missing the point.
NAV PERFORMANCE since launch
As we have discussed already, Ruffer has seen difficult periods before, notably in 2006 when the trust struggled to keep its head above water as the initial cracks appeared before the financial crisis, but the core argument for this trust can be seen in its performance over the longer term.
Investors have had a relatively easy ride since the last proper bear market in 2008, a year when the trust delivered positive returns of 24% while over the same period the market lost 29%. Since the fund was launched, it has delivered annualised returns of 7.29%, not far behind the FTSE All Share’s 9.27%, whilst keeping a tight grip on volatility; with a max drawdown over that period of -8.6% in stark contrast to the 47.7% recorded by the index.
DISCRETE Calendar Year NAV Performance
As a matter of policy, Ruffer does not target a specific level of income. The board believes this gives the team the flexibility they need to pursue absolute returns without worrying about seeking out yield as well. Indeed, the dividend was cut in 2017 as the portfolio was generating less income than it had been previously distributing – earnings from the revenue account being depressed by the heavy weighting in index-linked securities, illiquid strategies, gold and gold equities. At present the trust generates a yield of 0.8% paying dividends twice yearly. The team believes that paying the dividend out of capital (which they would be entitled to do) is contrary to the primary objective of capital preservation.
Hamish Baillie, Duncan MacInnes and Steve Russell are named managers on the trust. Hamish, who joined the team in 2002 and set up the group’s Edinburgh office, is lead manager on the trust. Hamish works alongside Duncan MacInnes, who joined the team in 2012, and Steve Russell. Steve joined Ruffer in 2003 and has more than 30 years’ experience in the City - he is also co-manager of the LF Ruffer Total Return, sister fund to the trust.
Ruffer Investment Company is effectively a microcosm of the much larger Ruffer business, set up by Jonathan Ruffer who still leads the investment strategy alongside CIO Henry Maxey. Ruffer has £21.1bn in assets (as at 30th November 2018) and 270 staff worldwide, all focused on the same ‘positive returns in all conditions’ philosophy. The trust has access to prodigious resources with more than 147 people solely focused on fund management and research, including 30 analysts.
Until last year the trust’s shares had traded at a sustained premium since the end of 2016, having before then traded in a range between a small discount and small premium for some years. Historically popular among wealth managers, the trust has seen growing demand among retail investors, and this part of the shareholder base has grown the most in recent years with more than 90m new shares issued since 2009.
More recently the trust has slipped to a rare discount, reaching at its widest point 6.9%, but coming back in again to rest at 3.5% at the time of writing. The trust has only once traded at a sustained discount: in 2007 the discount reached 7.5% and the board acted decisively, offering all shareholders an exit at NAV through a tender offer and repurchasing 16% of shares in issue at the time. We would be surprised to see the board take any similar action on the discount unless a sustained period of discount weakness occurred, and given the febrile feel of the markets at this point, the respect which the trust has among investors who remember its performance in the last crash – and the myriad risks to stability we now face – it is possible that demand for the trust’s shares is more likely to go up than down in 2019.
RICA has an annual fee of 1% and no performance fee. Its ongoing charge figure (OCF) is 1.18%. The KID cost (or reduction in yield) is 1.56%, compared to the Flexible sector average of 3.3%.