We consider that it is only these less conventional protections that will enable us to deliver continued growth in our portfolios, whatever is going on in the markets. And we believe that our credit and volatility protections can deliver performance that will effectively offset damage to our equities when the next dislocation comes. So, if conventional assets and traditional diversified portfolios cannot provide the protection required to keep portfolios safe in an uncertain world, what can? At Ruffer we accept that protection now must be paid for. But, as March showed, now it has been drawn into the liquidity party, it could be at risk when that liquidity recedes. And gold has an important role to play as a hedge against a loss of faith in paper money. But this has compressed their risk premiums to levels that, again, do not compensate for the extra risk, making them the opposite of protective. Some people have turned to corporate bonds for a bit more yield. It also means they offer a lot more risk than potential reward. That means bonds cannot effectively protect an equity portfolio. Only inflation-linked bonds are attractive in these conditions. Deducting the average long-term inflation rate would mean accepting -4.1% pa after inflation in the US and -6.5% in the UK. If, as we expect, the scale and scope of government spending marks the beginning of a new more inflationary era, then these negative nominal returns could be even less appetising. Inflation is unusually depressed, but positive even now. But you have to believe that they will go deep into negative territory, ignoring all the problems that would cause to the banking sector and to the economy, to imagine that investors would continue buying bonds with yields so negative.Īnd these are yields on conventional bonds, so represent the returns before taking inflation into account. It is true that the Bank of England has talked about negative interest rates (2). It shows that the 10 year US government bond yield would need to fall to -0.6% and the 10 year UK yield to -1.2% to do the job. The chart shows the level the yield would need to fall to for the bond part of a traditional balanced portfolio combining 40% bonds with 60% equities, to offset a mere 10% fall in the equities. But yields are already about as low as they have ever been. What drives the price of a bond up is when the yield, the interest rate paid compared to the bond price, goes down. Assumes bond exposure is all to the benchmark 10 year issue. Source: Bloomberg, Morgan Stanley and Ruffer analysis. The chart below demonstrates that bonds are very unlikely to do this job in the future. The result was that the risk adjusted returns, the returns adjusted for sleepless nights, from a traditional portfolio containing both assets was particularly attractive. This conveniently boosted the bonds just when the equities were suffering. Better still, when the equities fell, the automatic response of central banks has been to cut interest rates. The result has been that an investor combining equities and bonds has received excellent returns from both. ![]() Interest and inflation rates have been falling steadily since 1981 (1). This will be a shocking contrast to the last 40 years. In particular, we believe that conventional bonds will provide neither acceptable returns in good times, nor much protection in a downturn. And with the prices of all assets buoyed by abundant liquidity, we fear a traditional ‘diversified’ portfolio is not going to be much protection in the next market convulsion. Normally uncertainty translates into lower asset prices. The future looks even more uncertain than usual.
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