Vodafone Group (VOD)
Is the time right for absolute return funds?
It is a given that markets are driven by fear and greed. It would be logical, therefore, for investors to compose portfolios that ready themselves for the opposing energies of yin and yang.
But the majority of investors learn rationality only through painful experience, sometimes by unfortunate choices in fund managers who invest their money, such as those, for example, who were hawking technology shares at the turn of the century.
Right now, however, when every man and his dog realises we really are in the clag, the ever-energetic fund management industry has alerted on a product that, only a few years ago, it tended to scorn. Enter the absolute return fund, the term for multi-asset funds that roll their dice on tables that cover the investment casino - bonds, equities, currencies, commodities and so on.
As a package, absolute return funds are intended to produce a positive return regardless of the prevailing investment climate via a balanced allocation of assets. Assets of fear are those that should appreciate in the event of a market correction and protect value, such as fixed income, indexlinked bonds, currencies and commodities.
The balance of greed, on the other hand, is aimed primarily in the direction of equities, assets that share in corporate prosperity when times are favourable. The outcome? In short, absolute return funds tend be relatively pedestrian when equity indices are roaring ahead, but positive when the coin flips.
Yet the term can be a misnomer. Many absolute return funds, on an annual basis, return absolutely zilch, and some even sustain heavy losses. Not for nothing does Ruffer, a firm that earned City of London admiration for predicting and sailing through the credit crunch, describe its offering as CF Ruffer Total Return.
CF Ruffer Total Return is different
This fund is different: its twin investment aims are not to lose money in a 12-month rolling period and to beat Bank of England base rate. It spurns conventional benchmarks and regards cash as the only true yardstick. At the end of June, Ruffer had £13.4 billion under management, almost £5 billon of which was managed for private clients. The £2.4 billion total return fund represents its pooled approach; issued at 100p in 2000, it has since appreciated to around 320p, with some flat periods and only a handful of meaningful, periodic dips along the way.
Over five years, CF Ruffer Total Return is the clear winner in the category of funds that invest between 20% and 60% of their capital in equities, performance which earned it Money Observer's accolade of Best Absolute Return Fund for 2012.
This year, however, performance against the crowd has not been as kind. Five years ago, there were 80 funds in what used to be called the Cautious Managed category. Now, the total has almost doubled and CF Ruffer Total Return has slipped into the bottom half of the tables, leaving it in marginally negative territory for 2012. But managers David Ballance and Steve Russell are not dispirited.
"This is by no means unusual for us… there have been several such 'dull patches' in the past… it is perhaps a symptom of the difficult conditions that savers face," the duo wrote in their June bulletin to investors.
For Ruffer's private clients, individual segregated accounts are concentrated, typically holding some 10 bond and 20 to 30 equity positions. But the total return fund is different, and owns 109 equities. These equities represent roughly half the fund's assets. About one-third of the latter, through equities and bonds, are exposed to the US dollar.
Significantly, a whopping one-third of the fund's assets are also invested in index-linked gilts, one-third of which are UK gilts. The remaining two-thirds are predominantly US 'Tips', or Treasury Inflation-Protected Securities, although, among other countries, Sweden and Japan are also represented, but not Italy or France.
This focus on index-linked is one, all-important punt. But whereas many fund managers have no clear idea of where world economies are headed, and what lies on the road ahead, Ruffer, as a firm does not. But it is unequivocally "clear on what the outcome of this financial crisis will be".
In a word, inflation, plus more panic in sovereign debt markets and the view that recent rescue loans to beleaguered banks are not game-changers. The over-riding concern is the lack of economic growth in developed markets and, now, slowing growth in emerging economies as well.
Debt reduction plans of Western governments are predicated on some return to growth levels pre-2008. But Ruffer argues there is too much debt for austerity programmes to succeed and debt, therefore, "must be reneged upon… via stealth (inflation and negative interest rates) rather than a 1930s-style depression".
Ballance says he has no idea if there will be a re-run of the 1970s, when UK inflation exceeded 20%. "But we have isolated the risk and put our defences in place to guard against it. How will it happen? There are three aspects to think about. The first is massive printing of money; declining purchasing power, like the experience in Zimbabwe. Lots of money and no real wealth.
"At the moment, all this money that has been mobilised [by Western governments] hasn't been spent and is sitting in the banks. So we now have subdued velocity of money.
"In Europe, we are beginning to get capital flight," he says, with euros moving from the south to Germany, west to the UK and other perceived havens of relative stability. This influx means a further boost to money supply. Lastly, he says, interest rates will stay below inflation for a considerable period of time. "Years, not months."
The gold rush
Inevitably, Ballance is drawn to bring gold into his fear equation. As a firm, Ruffer was an early caller in the gold rush but Ballance became "quite frightened" when a bubble, largely caused by what professionals termed "the wrong kind of buyer", pushed the price toward $2,000 an ounce. Still, bullion has outperformed gold shares in the past 18 months, and Ballance rues the fact that he placed most of his bets on scrip rather than metal.
But, with the opportunity of a "moneyprinting bonanza" in an indebted world, "the time is right for us to have another go and increase our exposure to gold. People have always argued that gold does not pay an income. Yet people are now lending money to Swiss, Danish, and German governments that have negative returns for [respectively] six, four and three years. Some of these people might now be less reluctant to hold gold."
Ballance does not share the current passion, especially among private investors, for corporate bonds. And he sees derisory value in conventional gilts, where lending to the UK government for 10 years yields some 2%. He describes corporate bonds as "half bond, half equity". In an inflationary climate, he argues that profits will come under pressure, and points out that the Financial Services Authority is also concerned that investors may be trampled when there is rush of corporate bond money for the exit doors. "We would rather own a mix of blue-chip companies, the real thing, rather than these halfway houses. There are decent returns from companies such as Vodafone (VOD), yielding 6%. These, and index-linked, serve our purposes very nicely."
He adds: "There is nothing original in our preference for high-yield payers, companies with strong balance sheets, no big pension problems and no need to fund their forward growth."
The fund's US holdings include Johnson and Johnson (JNJ), Kraft () and Wal-Mart. (WMT) But the biggest equity bets are in Japan, which represents roughly one-third of Total Return's exposure to equities.
Ruffer has held a positive view of Japan for several years, with mixed results. Whereas some investors probably fear dying while waiting for Japan to "come good", Ballance is not swayed from his conviction. Japan will be a major beneficiary of rising global inflation, he says, and, sooner or later, the authorities will simply have to join western governments by putting together reflationary packages. "We are less keen on the blue-chip exporters and prefer Japanese banks, insurance and property companies."
In all, Japanese equities represent around 16% of Ruffer Total Return's overall assets. The UK stockmarket, in comparison, is around 12%. Many of the Japanese holdings are in small companies, which helps explain why the fund holds more than 100 different equities when private, discretionary clients, have more concentrated portfolios.
Ballance confesses he doesn't know more than anyone else about the likely outcome of the maelstrom in Europe, but has partly prepared for a possible break-up by placing 2% of Total Return's funds in German property stocks. "Germany never had a property boom and if the euro does break up, the Deutschmark would become the strongest currency." He reasons property would benefit from those who need real assets, and the five% rental yields now available contrasts with borrowing costs of between 2% and 3%.
Total Return's biggest currency exposure is to the US dollar, which accounts for one third of the fund's £2.4 billion of assets. "This is not because we think it is wonderful. It is the currency to borrow in the new carry trade… when equities fall the dollar goes up and it is a useful counterweight to equities." His mantra? "It is better to be approximately right than wrong."
Ruffer Investment Co: At a premium price for its "better ideas"
Anyone paying the best part of 110p for a one pound coin could reasonably be seen as a contender for the poorhouse, nuthouse or both. Yet, two years ago, investors were prepared to pay a near-10% premium for access to Ruffer Investment Company (RICA), the £280 million closed-end investment company that mirrors the portfolio of its stablemate, the open-ended CF Ruffer Total Return Fund.
Today, that premium to net asset value (NAV) generally ranges between 2 and 3%. Why? Co-manager of the trust, Steve Russell, who also shares management responsibilities for the open-ended investment company, accepts that, "generally speaking" it is dumb to pay a premium for assets but "some people will pay one if they consider it worthwhile". And, "rationally, investment trusts should trade at NAV or a small premium if the managers are doing a reasonable job".
Ruffer Investment Company was launched in 2004, four years after the OEIC, "to address a more professional audience than Total Return Fund… to give quoted access" to investors such as institutions. One of the benefits of the closed-end fund, Russell points out, is that its investors will "not have some of our better ideas diluted because of inflows of new money".
The trust's performance has been "slightly better" in the eight years since launch. Slight? "10%. This is partly because of the lower fee structure. The flip-side is that you pay NAV for Total Return Fund, not a premium."
To try and keep the premium below 4%, Ruffer makes "block issues" equal to 10% of capital to satisfy demand. To date, there have been three such issues. One of Ruffer's "better ideas" in the aftermath of the 2008 credit implosion was to buy US collateralised loan obligations (CLOs), a viable, corporate version of the wretched CDO packages that brought the global financial system to its knees.
These assets form part of the "illiquid strategies" that have delivered double-digit returns for investors in the investment trust and OEIC, as well as discretionary clients.
Profile: David Ballance
Position: Co-manager, CF Ruffer Total Return Fund
Education: Royal Grammar School, High Wycombe. Oxford, PPE
The past: CBI. Provident Mutual. Allied Dunbar Asset Management. Rothschild Private Management and of European equities, Threadneedle Investment Managers
Home: Central London. Three children. Classical music, the piano
Finances: "Stray funds and equities from a long time ago. My self-invested personal pension is wholly invested in my fund."
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