Ruffer Investment Company is one of a handful of “wealth preservation” strategies that seeks to protect and grow capital in a variety of market conditions. In 2022, it made a positive return, while most multi-asset funds made sizeable losses. In this interview, fund manager Duncan MacInnes explains what the biggest drivers of performance have been this year, including “put options” (betting against) some of the tech giants. MacInnes also explains why the portfolio’s equity weighting is at a record low, gives his views on the 60/40 portfolio model, and explains why he isn't tempted to buy back into crypto at lower prices.
Kyle Caldwell, collectives editor at interactive investor: Hello and welcome to our latest Insider Interview. Today in the studio, I have with me Duncan MacInnes, fund manager of the Ruffer Investment Company (LSE:RICA). Duncan, thanks for coming in today.
Duncan MacInnes, fund manager of the Ruffer Investment Company: Thanks for having me.
Kyle Caldwell: So, Duncan, Ruffer Investment Company is one of a small number of wealth preservation investment trusts, which seek to protect and grow capital in a variety of different market conditions. So how do you go about doing that?
Duncan MacInnes: Well, we've done one thing, that one capital preservation strategy since 1995, and we do it by trying to keep the menu of what we can own as wide as possible. So, we have this global multi-asset totally unconstrained, un-benchmarked approach, and our investment objectives are to, first, preserve capital, do no harm and, second, to try to grow the capital over the longer term.
Kyle Caldwell: And it's a multi-asset approach, could you talk through the types of assets that you invest in?
Duncan MacInnes: Yeah, so, if you go back to the origins of Ruffer, we could build that all-weather portfolio that we were trying to construct with conventional assets. So basically stocks, bonds, currencies, and a little bit of gold. What we found is, as we moved into the post-financial crisis period from about 2012 onwards, we were worried that you couldn't get what we call offsets. You couldn't get a protection in those conventional assets. So, we started to build expertise in what we call unconventional assets, effectively derivatives. So, we now have lots of those conventional assets, but a small bit of the portfolio in unconventional assets, which we utilise to try and increase the portfolio protection.
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Kyle Caldwell: So, the portfolio looks a lot different compared to other cautiously [managed] multi-asset funds. What do you make of the 60/40 portfolio that several multi-asset funds adopt? That's 60% in shares, 40% in bonds. Some commentators argue that it's become outdated, but it may also be reborn, given that there's more income on offer following the bond market sell-off?
Duncan MacInnes: So, if we were doing this a year ago, if we were doing this in Q3 or Q4 2021, I was doing a presentation at the time called ‘No, Mr Bond, I expect you to die’ because we were convinced that the 60/40 was heading for big trouble. The reason is that the industry relies on a negative stock-bond correlation, which is a bit of jargon. Basically when stocks fall, bonds will go up because interest rates usually come down. And that is a founding principle of portfolio management across the entire wealth management and asset management industries.
Our work shows that when inflation is above 3%, which is, of course, where we are today and where we have been for quite some time, that negative stock-bond correlation breaks down and stocks and bonds start to move in the same direction and that direction has been down.
So that's why 60/40 has been so poor. Of course, the expected returns of 60/40 have gotten slightly better as stocks and bonds have both fallen, interest rates and bond yields have risen. But if you believe in a higher secular inflation environment, then I think 60/40 still looks challenged. So, I think the outlook is better but still not good. Or the 60/40 isn't sufficient.
Kyle Caldwell: In 2022, most cautiously managed multi-asset funds, have lost money predominantly because they mainly just invest in shares and bonds. But your investment company, it's made a positive return, so what have been the key drivers?
Duncan MacInnes: So, year-to-date, we're up about 6%. The key driver has been that unconventional protective toolkit that I mentioned. And what's in that? What are the different investments that have driven performance? The single biggest contributor is something called a payer swaptions. So, I did these during my CFA exams, and I remember thinking that they would never be relevant to my life and then here they are very relevant to my life.
Payer swaptions are the right, but not the obligation, to enter a pay-fixed receive-floating interest rate swap. Gobbledegook. What they do is rise in value as bond yields rise. So, they're a hedge against bond yields rising. And of course, bond yields have gone up lots this year. So, they've contributed, I think, around 5% to our portfolio return.
The next thing that has contributed positively is equity put options. So, options that rise in value as stocks fall. Early in the year, we had puts on profitless tech companies, which was the right place to be pre the war. In February and March, we moved into European stocks, which, again, as the war broke out was a good place to have a hedge. And then more recently we've been using index and larger tech, Apple Inc (NASDAQ:AAPL) and Tesla Inc (NASDAQ:TSLA) puts, to protect the portfolio. So, they've been a strong positive contributor.
And then the last bit worth mentioning is credit protection. So, these are options or credit default swaps that rise in value, as corporate borrowing spreads widen. So, as the costs for companies to borrow money rises, these investments make money. Now, it is worth touching on the fact that these all sound like pretty complicated investments. We do use them solely for protection, to look after the portfolio downside. And they are also a small bit of the portfolio. So, they punch very hard, but they're usually less than 5% of the portfolio overall.
Kyle Caldwell: So those put options that you mentioned on the likes of Apple and Tesla seeking profit if those share prices fall, are they still in place today?
Duncan MacInnes: They are, yes. We still have them, we have less than we did. And if you go back a few months, we were overall positioned to do better if the market fell than if it rose. Today, we're more neutrally positioned, we're very slightly, positively exposed to the market.
Kyle Caldwell: And in terms of your equity exposure, it's an all-time low of around 14%. The last time I interviewed you on camera, which was at the start of 2021, you had around 40% in equities. That's a pretty big change. Could you explain why the equity weightings at an all-time low and what would need to happen for you to become more positive on equities and buy more?
Duncan MacInnes: You've touched on a point there. I think there's a common misperception about Ruffer that we don't move the portfolio much. But as you alluded to, we've moved the equity weighting quite significantly throughout this year and over the last year or two. And we do have the lowest equity weighting that we've ever had. Why? Yes, stocks have been poor this year. But I still think, this might surprise some people, that there's a lot of hope in the equity market. The equity market believes that four things can happen simultaneously, and we would be very sceptical about that.
So, those four things would be interest rates peak in Q1 of next year, maybe around 5%. This is the US we're talking about, maybe slightly lower in the UK and that interest rate will bring about the slowdown in the economy that central banks are trying to achieve, so they can bring down inflation.
Maybe there will be the sort of, often talked about but seldom seen, soft landing or perhaps a brief, mild recession. That slowdown will take all the inflationary pressures out of the economy and all that can happen with corporates still growing their earnings 8%, which is what Bloomberg estimates tell you is going to happen next year. The corporates can grow their earnings at 8%, while maintaining record high profit margins and they can do that potentially in a recession with rising labour costs and much higher interest rates, raising their financing costs. That seems like an unlikely set of circumstances for me. So, basically, we don't think the bear market is done yet, and that's why we've got a low equity weighting.
Kyle Caldwell: I know it's pretty much impossible to predict, but do you have a timescale on how long you think this bear market will run?
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Duncan MacInnes: I think it would vary depending on who you ask internally. We think that 2023 will probably be the second leg of the bear market and maybe I think it could be the bottom. But that does depend on who you ask. I think if you ask Jonathan Ruffer, this is a much more secular bear market, what will probably determine that, is the policy response. So, we think earnings will be lower next year. We think we'll probably get a recession in the US and elsewhere next year. And what do governments and central bankers do in response to that? If they go back to cutting interest rates and back to printing money, then maybe that is the bottom.
Kyle Caldwell: Also, the last time we spoke, which was around two years ago, you just bought some exposure to Bitcoin. And then you sold a couple of months later after we interviewed you and you made a big profit from those investments. Is crypto completely off the cards for the trust, or could you be tempted back in at these lower prices?
Duncan MacInnes: So, for those who don't know what we did, we bought 2% of the portfolio in Bitcoin in November 2020 at about $15,000. And we sold all of it by April 2021. So, five months later, our average exit price was $48,000. So, we did well out of that. It added about 4% to the portfolio return. I have never been more bullish on anything in my career than I was on Bitcoin in 2020. It just felt perfect for that macroeconomic market moment. You had zero interest rates, massive money printing, concerns about inflation. We were all locked up at home. The world was very uncertain and confusing. You had failing trust in institutions, and you had this desperation for investors to find something to diversify their portfolio. And Bitcoin looked like it could be that.
Kyle Caldwell: Today, I think none of those arguments still really stack up. We have much higher interest rates. We have quantitative easing becoming quantitative tightening. We have the availability of alternatives in cash and bonds. And, of course, Bitcoin has failed as an inflation hedge, some could argue. And the institutional investors, things like FTX, for example, has seriously damaged the credibility of the space and probably put its mainstream adoption back several years I would think. So, in summary, as of right now, there is no intention to revisit crypto.
Kyle Caldwell: Duncan, thank you for coming in today.
Duncan MacInnes: Thank you.
Kyle Caldwell: That's all we have time for today. You can check out the rest of our Insider Interviews on our YouTube channel where you can like and subscribe. Hopefully see you next time.
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