This week I have been thinking a lot about Macro Economics and how it impacts on how we invest money. It started on Tuesday when I sat on a panel with four other investment professionals at a wealth management summit to discuss ‘macro headwinds and tailwinds’ in front of an audience of 50 other investment professionals. It culminated yesterday when I read Ruffer’s review for 2023 on the train to Cornwall for a welcome long weekend in Newquay.

So, what is macro? Well, it’s the investment manager’s shortened name for the study of macro-economics, which if you look it up in the dictionary is described as:
relating to the branch of economics concerned with large-scale or general economic factors, such as interest rates and national productivity.

And it’s not easy, even for someone who managed (in the end!) to get a degree in physics and talks money most days of the week. There is the language to deal with along with concepts and processes that I often find difficult to visualise and model in my mind. Plus, everything comes with a but! To, quote Henry Maxey from the Ruffer review:

‘Eureka. Don’t we have an Archimedes’ principle for financial markets? If we can predict how liquidity will behave, we can anticipate the direction of financial markets.

Sadly, predicting reserves is not straightforward. The relationship between bank reserves and markets seems to have two-way causality. Exogenously driven changes in reserves impact markets: but market movements can also drive changes in reserves.

After a quick dictionary check I realise, that after a couple of pages of deep dive into the relationship between bank reserves and market pricing, we can’t read too much into it. It just happens to coincide, occasionally, but not always and we really don’t know where either is going next, nor which is driving which!

This is Macro, and why at the age of 61 and never having studied economics, I don’t get at all nervous about sitting on a panel with a bunch of other investment types to discuss it. It is not an exact science, with a modest grasp of some of the concepts you can sound like an expert and if someone is confidently predicting X to happen because of Y, there will always be a ‘but’ when it doesn’t.

So, how are those who study Macro feeling right now. Predictably, for a non-exact science most are swaying around in the middle ground: “it could all be just fine, or it might not”. Then there are those at opposing ends of the spectrum “we are very constructive on equities right now given the reopening of China and its return to growth and impact on the world economy” versus “we have never been more worried about equities right now and forecast imminent recessions in major economies”.

The lack of certainty in all of this is why we are long term investors in equity markets and don’t make big speculative bets on forecasts and possible outcomes. If studying macro gave us all the answers as to how to invest money no one would have been caught out by last year’s interest rate rises.

Of course, many analysts had been predicting that both inflation and interest rates would rise. The trouble is many had been predicting it for two decades and it would have been a terrible strategy to invest on the forecast of rising interest rates for the last 20 years right up to the summer of 2022. You would have passed up on some fantastic investment returns over those 20 years on the fear of losing some money when interest rates rose. Rates have now risen, and we survived! Capital values are down, but future income is up, and I suspect 2022 will look like a small dip in the chart in 5-10 years’ time.

So, taking stock of the weeks’ debates and reading:

 

The certainties we can see are:

1. 1. Equities are more attractively priced today than they were at the end of 2021

1. 1. Bonds are offering substantially more attractive forward-looking returns than they have for the last decade.

The factors that we think will play out, but can’t be 100% certain on, are:

3. 3. Bonds are unlikely to suffer a further big price drop from here as they endured in 2022. The risks to this are bigger for long duration bonds rather than short duration bonds which is where we are mostly focused.

3. 3. With a significant increase in the cost of money it will be a lot more expensive for companies needing leverage to fund themselves and investors will want more certainty in returns and will be less likely to speculate. This suggests to us better returns from more disciplined, traditional ‘value’ style investing, than piling into the next big hope. Again, we are positioned to take advantage of this but are not betting the ranch.

Finally, we can see outlying risks that could cause havoc. Whether any of these will come to pass we don’t know. The extent to which any of them are already priced into market values, we don’t know. Their long-term impact on prices after any initial shock we also don’t know. But here are the big ones, there may be others none of us can see:

5. 5. Nuclear escalation in the Russia Ukraine conflict

5. 5. China invading Taiwan

5. 5. Central Banks pushing interest rates too high for too long and causing bigger recessions than currently anticipated

5. 5. Food shortages continuing to push inflation

5. 5. Further fall out in banks from the steepest rise in interest rates in post war history,

5. 5. A real estate collapse

5. 5. A further energy crisis

There is plenty to worry about. But remember these are outlying risks, not certainties. Are Berkshire Hathaway and Warren Buffet selling equities and buying gold? No. Bull markets need worried investors, that is why prices rise as worries pass. There will always be a list of risks, it is just life.

This is though why we have been opening a position in the Ruffer fund which you will see in your portfolios as some insurance against these risks. Nick below explains what Ruffer do, why we have chosen them and how we have sized the position.

 

Philosophy:

The Ruffer investment process is differentiated from the majority of their peers, primarily designed to protect and then grow the value of investors’ portfolios – avoiding large losses first and foremost then harnessing the power of compounding over time. This singular safety-first investment strategy has been employed by Ruffer since the firm’s inception in 1994.

The aim of the Ruffer Diversified Fund is twofold:

• • Not to lose money on any 12-month rolling basis

• • To generate returns meaningfully ahead of the return on cash over the long term.

 

Portfolio Construction:

To achieve their mandate of a positive rolling 12-month return the fund holds a mixture of growth and defensive assets. The asset allocation is dynamic and unconstrained with the result being a global portfolio which looks very different to their peers. Currently the portfolio can be broadly split into the following three buckets.

Inflation Volatility: Index linked gilts, gold exposure & gold Equities – These holdings reflect Ruffer’s view that we are moving to a higher inflationary environment.

Protection strategies and Cash: Short-dated bonds, cash, protection strategies and options – Diverse protection against the risk of a further sell-off in markets. Very liquid with capital able to be put to use at short notice should opportunities arise or investors request some of their capital back.

Growth: Commodity exposure and Global Equities. Exposure is currently at the lower end of their range which reflects their current view that you are not being adequately compensated for owning Equities.

Portfolio Fit:

The Ruffer Diversified Return fund forms part of Tideway’s alternatives bucket and is allocated to as a portfolio diversifier historically exhibiting low correlations with major asset classes (Equities and Fixed Income) and other fund selections in the Tideway portfolio. It holds assets which are not directly allocated to elsewhere in the portfolio including index linked securities, gold and government bonds. The fund sits in the Investment Association’s Absolute Return Sector.

The primary aim of allocating to this particular strategy is to provide additional portfolio protection should another negative market event occur, and risk assets fall further from here.

As illustrated in the next section it should be noted that returns will most likely not arrive in a linear fashion with outsized returns typically being delivered when traditional markets are weak whilst typically underperforming when these same markets are strong, lowering overall portfolio volatility. In the event of the latter scenario, we have plenty of risk assets elsewhere in the portfolio to make up for this.

Although past performance is not a guide to future returns, we do not feel that holding this strategy should dilute long term returns with the fund having returned a healthy 8.7% annualised since the firm’s inception in 1994. For comparison the FTSE All-Share has returned 7.0% annualised, FTSE/MSCI PIMFA Balanced 6.7% and the Bank rate 2.9% annualised over this same period.

Performance:

2022 was a strong period for the fund in relative terms returning +5% versus a market where most major asset classes were in negative territory. These positive returns were largely achieved through allocations to protection strategies as highlighted in the portfolio construction section: interest rate protection largely hedged out their long duration exposure in Index-linked bonds whilst Equity downside protection and Credit protection also delivered positive returns.

Equity downside protection was executed through a combination of single name stocks (put options – effectively selling short) in profitless tech companies (with these companies now having to finance themselves at non-zero rates) which was rolled into larger tech companies once value was realised. Index puts on European indices that were implemented due to the proximity to the Russia Ukraine war also delivered positive returns. Furthermore, the team’s Equity selections focused on the cheaper end of the market also delivered positive returns which was consistent with our value Equity strategies held elsewhere in the portfolio. Exposure to gold & gold equities were a detractor.

2023 to date has been a more challenging period for the fund with the protective strategies that contributed to positive performance in 2022 being the main headwind to performance as Equity markets were strong to start the year.

The other main detractor has been a loss on foreign exchange with Sterling strengthening against a basket of traditional safe-haven foreign currency assets including Japanese Yen, US Dollar and Australian Dollar. Although Equities also positively contributed to performance the fund was hurt in relative terms with commodities markets proving relatively weak whilst wider Equity market performance was largely concentrated in more expensive names; in the US in particular, the breadth of the recovery was very narrow with just a handful of stocks driving the majority returns. Other positive contributors include index linked bonds and gold which was the reverse of 2022. See the April factsheet for current portfolio positioning and latest commentary from the fund manager.

Although the manager does not like to lose money, even over short time periods, it remains important not to judge a strategy over one quarter’s worth of performance. The long-term track record of Ruffer’s strategies remains excellent since the inception of the firm’s inception in 1994. Even more impressive are the returns achieved in times of market stress expertly navigating the Dot Com bust, the Global Financial Crisis and Covid-19 as evidenced.

	2003	2009	2020
Ruffer	-0.8%	10.3%	5.6%
FTSE All-Share	-29.8%	-29.9%	-18.5%
Bank Rate	4%	4%	0.8%
MSCI PIMFA Balanced	-21.6%	-18%	-7.9%

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