Ruffer Regulatory News (RICA)

Ruffer Investment Company Limited

(a closed-ended investment company incorporated in Guernsey with registration number 41996)

LEI 21380068AHZKY7MKNO47

17 January 2022

Investment Manager's Period End Review

For the period ended 31 December 2021

The following review from the Investment Manager of Ruffer Investment Company Limited (the "Company") covers the six month period to 31 December 2021. This review is intended to give shareholders unaudited key performance indicators and a portfolio review in a timely fashion. The unaudited Interim Financial Statements for the period ended 31 December 2021 will be released in the usual manner prior to the end of March 2022.

Attached is a link to the Period End Review - http://www.rns-pdf.londonstockexchange.com/rns/5500Y_1-2022-1-14.pdf

The Period End Review is also available via the Company's Investment Manager's website

www.ruffer.co.uk/2021-ric-review

Key performance indicators

Financial highlights

1 Assumes reinvestment of dividends

2 Dividends paid during the period

3 Dividends paid during the period divided by closing share price

4 Calculated in accordance with AIC guidance

5 NAV per share as released on the London Stock Exchange

Investment Manager's report

Performance review

The NAV total return for the six months to 31 December 2021 was 2.8% and the share price total return was 2.6%.

The calendar year share price total return of 12.7% and the NAV total return of 11.4% mark three consecutive years of good returns for shareholders (+37% in NAV total return performance over 2019-2021). The annualised NAV total return since inception of the Company in 2004 is 7.8%, which is ahead of UK equities with a much lower level of volatility and drawdowns.

Performance contributions for the six months to 31 December 2021

In the six months to 31 December 2021 the largest contributor to performance was index-linked bonds, which added 1.9%. This return was boosted by some active trading and duration management during the period. Purchases were made of long-dated index-linked gilts in June and these were trimmed in August. In November we bought the new 2073 issue and then reduced other long dated index-linked bonds in December. The long-dated gilts rose more than 10% over the six months.

This was a period of rising inflation and interest rates and thus it was crucial we had interest rate protection to offset the portfolio duration. This added 1.3% to performance. Gains in equities (+1.8% contribution) were almost entirely offset by the increased use of equity put protection which cost 1.6%.

Standout contributions came from Marks & Spencer (+54%) and Tesco (+29%) as private equity bid for Morrisons and Asda.

The period was characterised by a rotation within rising markets back towards 'old regime' trades of growth and quality outperforming value. Bond yields behaved in a more benign fashion.

Performance contributions for 2021

For the calendar year 2021 the key driver of returns was equities. With an average of 40% of the portfolio in equities through the year and a contribution of 10.3%, it can be inferred that the average equity rose by more than 20%. Since the summer of 2020 we have been increasingly focusing the portfolio on stocks which will benefit from recovery, re-opening and cyclical growth. These stocks have also tended to be 'value' in nature. They have been the best performing part of equity markets.

Energy stocks (BP, Royal Dutch Shell, Equinor and Chesapeake Energy) contributed handsomely, adding 2.0% to performance and rising around 40% on average - they remain key portfolio holdings. UK and European banks (Lloyds, NatWest, Barclays, Unicredit and Banco Santander) added 1.8% to performance with the standout being the Italian bank, Unicredit, rising 59% since purchase in April 2021.

Idiosyncratic opportunities were aplenty in the aftermath of covid disruption. Europcar Mobility (+70%) was purchased in April and bid for at a large premium by Volkswagen in July. It is a rare situation where the acquiror and the acquiree are both in the portfolio but Volkswagen (+19%) and General Motors (+40%) both also grew profits handsomely. The two UK listed shipping companies - Tufton Oceanic Assets (+58%) and Taylor Maritime Investments (+46%) - took full advantage of the boom in charter rates because of supply chain chaos. It says more about the buoyant market than our stock picking genius that it is hard to find a stock we lost a meaningful amount of money in.

On the protective side of the portfolio, equity puts were a drag on performance, costing 1.4% over the 12 months. However, we remain positioned here to guard against the sky-high valuations and the resulting risk of a market sell-off.

Ruffer Multi-Strategies Fund added 0.4% for the year. In simple terms this amounts to a contribution of 2.0% from bitcoin and losses of 1.6% from credit protection.

Gold exposure cost the portfolio 0.9% over the year. The safe-haven characteristics of gold failed to fully materialise during the covid crash, and with the growing interest in cryptocurrency potentially usurping gold's position as an inflationary hedge, the perception of this asset class has changed. While the 'barbarous relic' appears to lack many allies, we have maintained our interest, along with our conviction of its protective qualities.

Portfolio changes

1 We continue to actively manage the duration of the portfolio using interest rate options to protect the portfolio against rising interest rates and bond yields.

2 Profits have been taken in equities to keep the overall weighting close to 40%.

3 We have reinforced the unconventional protections in the portfolio by adding to Ruffer Multi-Strategies Fund and Ruffer Protection Strategies.

Investment outlook

Summary

1 An excess of excesses - it appears that markets have become untethered even from the robust economic growth of the post-covid economy. There are plentiful signs of irrational exuberance.

2 The inflation conundrum - we have transitioned into a new economic regime of higher inflation and volatility and this will force hard decisions upon policymakers.

3 The devil and the deep blue sea - we are resolutely bullish on the prospects for economic growth in 2022, but the delicious irony is that the stronger the economy is, the more vulnerable fragile capital markets look as policymakers will have to press the brakes harder. What the economy needs, markets can't handle.

4 Hard choices - given the uncertainty of the journey from here it is essential that investors have an all-weather portfolio with appropriate hedges in place. A resumption of the 'old normal' is the least likely outcome.

An excess of excesses

At Ruffer we always focus on capital preservation and eschewing the mania. A significant source of outperformance has been not owning the frothiest areas of the market when the cycle turns. Today there appears to be a lot of froth. To set the scene it is worth recapping some of the extraordinary things that happened in 2021.

2021 might be remembered as the year investors tumbled down a rabbit hole and entered financial wonderland. The stock market went mainstream in a fashion not seen since the late 1990s. Investors have poured more than US$1 trillion into equity funds in the past 12 months - more than the combined inflows of the past 19 years.

Global M&A topped US$5.8 trillion, surging more than 50% and marking the fastest year over year growth since the 1990s (Source: Financial Times, 30 Dec 2021). IPO capital raised and stock buyback volumes also broke to record highs.

SPACs (Special Purpose Acquisition Companies), effectively blank cheque shells, were all the rage. In 2021, more than 500 - double the previous record year - underwent their initial public offering, raising just over US$100bn (Source: Reuters, 23 Dec 2021). These were often backed by celebrities (Serena Williams, Andre Agassi, Shaquille O'Neill, and Jay-Z) and operate in hot sectors such as space exploration or electric vehicles.

Celebrities were also courted by cryptocurrency companies flush with cash from their own boom. Matt Damon and Tom Brady starred in high profile television commercials and crypto.com paid US$700m for the naming rights for the LA Lakers stadium (Source: LA Times, 16 Nov 2021). This venture capital tsunami helped cryptocurrencies to a total market capitalisation of US$3 trillion (Source: Bloomberg, 8 Nov 2021).

Events like the GameStop or AMC short squeezes revealed a tribal, anarchic and often bizarre mix of new participants for whom apps like RobinHood had gamified trading.

Billion-dollar start-ups, colloquially known as 'Unicorns' because of their rarity, became customary. 2021 saw more than 300 minted. Of these Rivian, a new electric truck manufacturer, became the first company in history to achieve a US$100bn valuation with less than US$1m of revenue (Source: The Guardian, 10 Nov 2021).

The previously arcane world of derivatives was popularised, with the value of options traded surpassing stocks for the first time ever. Tesla alone trades more than US$200bn notional value per day, which is several multiples of the entire UK or European exchanges (Source: Financial Times, 23 Nov 2021). Lastly, Elon Musk was named Time magazine Person of the Year - echoing Jeff Bezos in 1999 at the peak of the dot.com bubble (after which the Amazon share price fell more than 90%).

In short, there was an excess of excesses, and this makes us cautious. As venture capitalist Josh Wolfe said "Overloaded with credulity and fuelled by greed. The masses have thrown caution to the wind and diligence to the dogs."

It was the best of times

As you might expect, underneath all these signs of rampant capitalism, the underlying economy is doing well; pent-up demand, strong growth and household net worth at all-time highs have combined with continuing monetary and fiscal stimulus to produce this environment.

The Atlanta Federal Reserve 'NowCast' has US Q4 2021 real GDP at 7%; add 6% CPI inflation and you get a 13% nominal growth rate. The growth picture is similarly robust in Europe and the UK. One would have to go back around 50 years to find a similar surge.

With this backdrop, does the US really need the easiest financial conditions on record? Of course, this is helping us, and many others, make good returns for their investors, but policymakers are still running emergency levels of monetary and fiscal policy support when the economy is firing on all cylinders with a tight labour market.

The Goldman Sachs Financial Conditions Index is a composite including interest rates, equity valuations, borrowing costs and currency data to assess how 'easy' or 'tight' financial conditions are. This offers a broader gauge than the blunt tool of interest rates. The message is clear - we've never had it so easy.

The inflation conundrum

Looking at 2022, the fly in the ointment is inflation - from energy and housing to wages, raw materials, and food. In a nutshell, too much money is chasing too few goods. There is no denying the inflationary impulse has endured longer than many expected. Inflation is currently at its highest level in around 40 years and has made a clear break from the previous trend.

We are now experiencing the common knowledge of inflation; it is dinner party chatter. Everyone knows that everyone knows there is inflation, which makes raising prices or asking for a pay rise that much more palatable. This is how reflexive processes are born and many are risking their credibility by failing to acknowledge it. Former Treasury Secretary and Harvard Professor Larry Summers said, "I believe the gap between the Treasury & Fed statements and the everyday experience of businesses and consumers has perhaps never been wider."

The Federal Reserve and several administrations have spent a decade post-financial crisis trying to create inflation and now, like tomato ketchup from a glass bottle, they've got too much all at once.

The Biden Administration (and others around the world) will struggle to implement their high spending, deficit-fuelled big society, or climate change programs, if inflation stays elevated. Additional stimulus at this point would be like pouring gasoline on a fire. Even the Modern Monetary Theorists confess the only constraint on government spending is the emergence of inflation. Thus, putting this genie back in the bottle is imperative.

Perhaps because of these political pressures, the reaction function of the Federal Reserve is different this cycle. The Fed has moved from pre-emptive to reactive with a lag. They are deliberately behind the curve.

The devil and the deep blue sea

If, and it remains an if, inflation in advanced economies persists above 2%, central banks will have to decide between the devil and the deep blue sea. Do they stick with the current run-it-hot strategy, out of concern for financial stability and encouraging a broad and inclusive labour market recovery? Or do they revert to their more traditional policy approach, getting 'ahead of the curve', tightening those easy financial conditions but running the risk of a policy-induced recession, market tremors and the accompanying political fallout?

As former Federal Reserve Chair McChesney Martin once said - "the job of the Fed is to take away the punch bowl just as the party gets going". We believe they are coming under increasing pressure to poop the party. This is relevant because the economic boom and asset prices have floated higher on a sea of abundant liquidity and stimulus.

The Fed may have to choose between either financial market pain or inflation pain. To tackle the inflation pain they need to withdraw liquidity and raise rates - but that will almost certainly cause market pain. What the real economy needs today (higher interest rates), financial markets can't stomach. Stock markets are up 40% over two years (Source: Ruffer LLP, Factset), yet wealth inequality is at all-time highs in a boiling hot economy.

In reality, tapering amounts to less easing rather than meaningful tightening; interest rates will remain negative in real terms and near multi-century lows. But prices are set at the margin - markets respond as much to flows as they do to the stock - and financial conditions will tighten. Flows and liquidity have been crucial to this bull market, and they may be about to reverse.

Alternatively, if they don't tighten then the inflation pain will continue and will arguably get worse because the economy is strong, inflation is a reflexive phenomenon and policy remains extremely stimulative. The real risk-free rate is around -6%. As Jerome Powell famously said before the 2018 market wobble - we are a long way from neutral. The last time the Fed tried to raise interest rates meaningfully the S&P 500 promptly fell 18% (Source: Ibid), forcing Governor Powell to reverse course.

In a highly financialised world, the conundrum for policy makers is that in taming inflation and moderating growth they must reverse the very conditions that have been so beneficial for markets.

Investment consequences

The return of inflation has brought with it a new dilemma. Markets love certainty, but pricing uncertainty is hard. The long-standing complacency around low and stable inflation can be seen in term premium - the extra yield earned as compensation for the uncertainty that comes with lending for longer periods - which has progressively fallen and is now zero or negative. The end of this certainty points to asset prices falling and yield curves steepening.

Inflation insouciance

The wisdom of crowds ensures that usually the consensus opinion in markets is correct, but occasionally markets are poor at predicting the future - particularly at turning points.

We currently have the highest reported inflation since 1982. What is really fascinating, however, is the forward looking inflation expectations priced into the inflation swaps market. Markets don't believe the world has changed. They are priced for a return to the low growth, low inflation, low rate post-GFC environment.

At the market bottom in April 2020 (the peak of lockdowns), the market was seeing deflation in the short term, but looking out a few years our magical, miracle-working policy makers would have inflation right back at their 2% long term target.

The market was completely wrong - it thought we would be experiencing deflation and very low inflation in 2021, instead we got 6% inflation. Today with inflation already high, the inflation swaps market is saying inflation will stay high for a while but looking out a few years will gravitate back to 2%.

This is the power of the paradigm of central banker omnipotence. This is the insouciance of markets undeterred despite a glaring forecast error in recent history.

We believe the macroeconomic environment has changed, but the investment environment has not yet caught up. This is the opportunity - because the market is complacent about these risks, they are not priced in. Long term inflation expectations rising would be hugely beneficial for inflation-linked bonds.

Hard choices

Longer term, our conviction is high that a new regime of more persistent and malign inflationary pressures has begun, but the journey before us is still unclear. This means we are as worried about inflation volatility as we are a higher average level of inflation.

One pathway involves a direct route to our inflationary destination; the other a path first through financial disruption and disinflationary dangers.

If we have not entered a new regime, we return to The Great Moderation of low and stable growth and inflation. Our portfolio will underperform equities in this benign scenario, but we still believe we have enough to generate a positive return. We believe this would be a fleeting scenario rather than an endpoint because of the changes to the political economy post-covid-19. There is now a populist desire and a political mandate for greater levels of stimulus to kickstart the economy, tackle climate change, increase wages and to redistribute wealth to those with a higher propensity to spend, which moves you back to the first question.

If we have moved into a new regime, our base case, there are two likely scenarios depending on whether policymakers try to tame inflationary pressures.

1 Tightening induced slump - inflation stays high and policymakers stem inflation with a sharp tightening of both monetary and fiscal policies. This could trigger declines in most asset classes, but especially in more highly valued, speculative sectors. In the portfolio we believe our unconventional protections in equity puts and credit protections would spring to life and help the portfolio as they did in Q1 2020.

2 Inflationary boom - inflation remains high but central bankers keep monetary and fiscal policy loose due to political pressure and to assist achieving soft goals like redistributive wage growth and climate change. Bonds and bond proxies look vulnerable in this environment. In the portfolio inflation-linked bonds with the duration hedged via payer swaptions and gold exposure would be two pure expressions of rising inflation. Value stocks and those sensitive to real GDP growth would do very well.

Regardless of the path, inflation risk, an absent concern throughout the careers of most investors, will need to be priced once again. Therefore, we have built a portfolio robust to both 'left-tail' and 'right-tail' outcomes.

What does a financial tightening look like?

Quantitative easing is being withdrawn and asset purchases are scheduled to stop by March 2022 (in the US). Interest rates are likely to begin rising after that and many smaller central banks globally are already moving in this direction including the Bank of England. The fiscal impulse is likely to turn negative as large covid-related stimulus packages roll off and taxes increase. The US dollar is rising, the DXY index up 7% for 2021 (Source: Ruffer LLP, Factset). Rising commodity prices, particularly energy, are squeezing cash flows at a corporate and household level.

Homer Simpson's ideal investments

Homer Simpson once observed that beer was the cause of, and solution to, all of life's problems. We view the 15% of the portfolio allocated to energy stocks and financials as having similar characteristics.

Beginning with energy, given current economic strength one of the few visible risks to derail the economy in the short term is rising energy prices. This naturally acts as a brake on growth, and as a tax on the consumer (particularly in Europe and Asia). Our allocation to energy stocks, covered in the June 2021 Annual Report, offers a neat hedge to this risk and an interesting each-way bet - one major source of crisis could be a spike in the asset we own, or alternatively, the stocks are highly geared to a continuation of economic growth and re-opening. We continue to engage with the companies we own to help and encourage them on the energy transition journey.

With financials, it is simply that these assets benefit from rising rates or a steepening yield curve. This is a rare and valuable characteristic. One clear risk to the economy and market is that the Fed raises rates too fast. In this scenario bank earnings will be mechanically rising due to a widening net interest margin and the banks are still highly provisioned due to unused covid loss reserves. In the event the economy keeps performing, banks are an excellent proxy for improving economic prospects and will continue to benefit from rising collateral values and diminishing loan losses. 

These two themes exemplify what we try to achieve in the portfolio. We have strong views, and we express them boldly in our asset allocation. However, we are not return maximising, we are regret minimising. Rather than thinking about how much we might make if we are right, we start by thinking how we can ensure we preserve capital if we are wrong. From that foundation, we can build the rest of the portfolio to capture returns.

Conclusion

One thing is clear - no one asset, nor single strategy, can guarantee success in this path-dependent world. We are in uncharted waters from a market and economy perspective, nobody knows how all of this will play out.

Instead, for a new regime, investors will require a diverse toolkit - flexible, adaptable, and robust. At Ruffer, we believe we have built exactly that. How are we positioned for this world?

For bad market outcomes we've got the unconventional toolkit- index-linked bonds, credit protection, payer swaptions, gold exposure, and equity put options. This is what you would expect from Ruffer: a preoccupation with downside protection.

For rosier outcomes - because there's a chance we have another roaring twenties, we've got attractively priced GDP- and inflation-sensitive equities.

Where we think investors don't want to be is in the middle of the road - a resumption of the old regime of low and stable growth and inflation. The winners of that regime - growth stocks, long duration assets such as venture capital and renewables and conventional government bonds - look to us like they offer no asymmetry and are already pricing in victory. As liquidity is drained from markets these crowded trades look to us the most dangerous.

Portfolio statement

as at 31 December 2021 (unaudited)

* Ruffer Protection Strategies International and Ruffer Illiquid Multi Strategies Fund 2015 Ltd are classed as related parties as they share the same Investment Manager (Ruffer AIFM Limited) as the Company. LF Ruffer Gold Fund and Ruffer SICAV Global Smaller Companies Fund are also classed as related parties as their investment manager (Ruffer LLP) is the parent of the Company's Investment Manager.

Appendix

Regulatory performance data

† From July 2004

Source: Ruffer, Bloomberg, FTSE International. Please note that past performance is not a reliable indicator of future performance. The value of the shares and the income from them can go down as well as up and you may not get back the full amount originally invested. The value of overseas investments will be influenced by the rate of exchange. Calendar quarter data has been used up to the latest quarter end. This document is issued by Ruffer AIFM Limited (RAIFM), 80 Victoria Street, London SW1E 5JL. Ruffer LLP and Ruffer AIFM Limited are authorised and regulated by the Financial Conduct Authority. Ruffer AIFM is a wholly owned subsidiary of Ruffer LLP. © RAIFM 2022 © Ruffer LLP 2022.

This document, and any statements accompanying it, are for information only and are not intended to be legally binding. Unless otherwise agreed in writing, our investment management agreement, in the form entered into, constitutes the entire agreement between Ruffer and its clients, and supersedes all previous assurances, warranties and representations, whether written or oral, relating to the services which Ruffer provides.

The views expressed in this report are not intended as an offer or solicitation for the purchase or sale of any investment or financial instrument. The views reflect the views of RAIFM at the date of this document and, whilst the opinions stated are honestly held, they are not guarantees and should not be relied upon and may be subject to change without notice.

The information contained in this document does not constitute investment advice and should not be used as the basis of any investment decision. References to specific securities are included for the purposes of illustration only and should not be construed as a recommendation to buy or sell these securities. RAIFM has not considered the suitability of this investment against any specific investor's needs and/or risk tolerance. If you are in any doubt, please speak to your financial adviser.

The portfolio data displayed is designed only to provide summary information and the report does not explain the risks involved in investing in this product. Any decision to invest must be based solely on the information contained in the Prospectus and the latest report and accounts. The Key Information Document is provided in English and available on request or from www.ruffer.co.uk.

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