Alexander Chartres of Ruffer tells Property Chronicle how past crises inform the wealth manager’s outlook as the world economy approaches a turning point
On the wall of Ruffer’s office in a modern glass block on London’s Victoria Street is one of the earliest surviving examples of paper currency, a Chinese bank note dating from the late 14th century.
For Alexander Chartres, investment director at the firm, the A4-sized banknote provides a telling lesson for those managing assets in uncertain times. Half a century after its issue the Chinese authorities, scarred by inflation, stopped printing paper currency and did not issue any further notes for 400 years.
Chartres is not necessarily predicting a similar outcome to the massive bout of money printing seen in the wake of the financial crisis ten years ago, but he certainly believes we may be at a turning point, with the economic and political consensus seen since the Berlin Wall fell 30 years ago now under threat. For much of that time the US and China have both pursued economic growth above all other policies. But now more protectionist measures are being suggested on both sides, as President Trump tries to protect US workers by putting America first and President Xi seeks to quell democracy protests.
“China is a 5,000-year-old civilisation, and the bottom line of Chinese regimes, whether imperialist, republican or communist, is domestic harmony. They will always pull down the shutters if that’s what’s required to ensure cohesion,” says Chartres, a geopolitical expert. “What we are seeing now in Hong Kong is therefore historically resonant. We have been used to a world order and society where the commercial and financial imperative has trumped everything else post-Cold War. That has changed. We are now in an era where geopolitical issues will dominate the financial and economic landscape once again.”
He fears the benign period of China and the US both pursuing economic growth as a prime policy goal therefore is near to ending, with consequences for investors globally.
“The new cold war between them threatens to unwind the close Sino-American economic relationship, and that could profoundly reorder global finance.” At the same time, negative interest rates and other emergency measures used since the collapse of Lehman Brothers in September 2008 have put asset prices in dangerous bubble territory, he believes.
When we meet, 30-year German government bonds are yielding just 0.2% and over US$13trn of bonds globally have negative yields. The 30-year bonds have since gone negative, making the whole German curve negative for the first time ever. Chartres says this is bad news. “We are in Alice Through the Looking Glass territory. Investors are paying heavily indebted governments for the privilege of lending them money,” he says. “Markets have lost their sense of historical perspective. It will end in tears, as it always does.”
He cites century bonds issued at very low yields in recent years by Argentina and Austria, both countries with troubled pasts. “Argentina became independent in 1816 and has been in default or restructuring for roughly one in every three years since then. Austria has only existed as a republic for 101 years and has seen hyper-inflation in that period.”
Record low rates on government bonds cause bubbles elsewhere. “If interest rates are the anchor on which all assets are based, then if you corrupt them the ripple effect will be seen through the whole financial system and distort everything.” This is because institutions and other savers who require income are forced out of traditionally safe assets, in the search for yield, into others that are more fundamentally risky, such as corporate bonds and equities.
If, like Ruffer, you maintain that the cycle will eventually turn, all this means “finding safe places to hide if you value capital preservation and want to avoid catastrophic losses becomes trickier”, says Chartres. “People need to park their money somewhere safe, and actually they don’t have much choice. They are faced with assets that are conventionally ‘safe’ but now are at extremely rich prices, meaning they are anything but safe if modest inflation were to creep back into the system, or economic growth were to falter.”
For this reason, one of Ruffer’s core holdings is index-linked gilts, which reflect UK inflation measures, providing proportionately higher returns if inflation rises. “Rates and inflation may not go up immediately, but we are confident that a decade of extreme distortion has sown the seeds of an incredible bull market in assets.” Chartres reckons this will end at some point. “Rates can’t stay nailed to the floor forever. The system will eventually collapse under the weight of the distortions wrought by those same low rates.”
Part of the problem is that policy measures taken in 2008 to address a major leverage crisis ended up putting more leverage in the system. “In aggregate, debt has mushroomed further. If you make money free by cutting rates to the floor, people will borrow more. The authorities have tried to solve a debt crisis with more debt,” he says.
Private equity investors and real estate owners have been among the major beneficiaries of the asset boom, he points out. But the recent liquidity crises seen with funds, as investors have wanted to make withdrawals – whether from property funds following the Brexit referendum or from more mainstream funds – indicates problems ahead.
“Rather like bank runs, most of the time people don’t need their money at the same time, but if they did, there would be a problem. Lots of funds give the illusion of liquidity – like a bank account – but that will evaporate when everyone has the same idea. Imagine someone shouting ‘Fire!’ in a crowded theatre and everyone has the same idea to go for the exit.”
This rush for the door seemed to start in the last half of 2018, but ultimately it proved a bit of a false dawn. “Even if markets are avalanche-prone, it does not mean they are going to snowball imminently. There have been clear examples in the last 12 months of how sudden stresses in markets can hit the entire edifice, but the authorities have every incentive to try and keep the show on the road as long as possible,” says Chartres.
Ruffer’s aim is to be positioned ahead of any major slump by holding a range of protective assets that will profit from a market crash, as well as inflation-linked gilts which should prosper if interest rates remain low and inflation starts to rise. “Our approach is to avoid a catastrophic loss of capital largely by focusing on what big risks are likely to be years in advance, and, by long-term compounding, deliver decent results. It is better for us to be three years too early than three minutes too late. We will usually get off the bus a few stops early.”
Chartres says that with trust breaking down between the globe’s two major economic powers of China and the US, investors will need to learn to traverse a volatile world of great power competition once again, something none have had to do over the last 30 years.
Although he thinks asset prices face a correction, he notes property may be more robust than other asset classes. “Average residential property in London is valued at something like 15 times average national wages. Asset prices cannot grow indefinitely without the economy supporting them. Property might hold its value in nominal terms, but it seems unlikely to outstrip other assets in real terms from this starting point. There needs to be time for incomes to catch up with property prices,” he says.
On the equities front, around 40% of Ruffer portfolios are in high-conviction ideas. “We think the world is very content-hungry. Children will still watch Disney films and listen to Universal Music’s back catalogue and play computer games, so we like Disney, Sony, Vivendi and others.”
But from a macro perspective, he says investors should focus firmly on how China might react to any internal political unrest, such as the ongoing protests in Hong Kong. Meanwhile, the shibboleth of central bank independence is drawing to a close, with politicians increasingly keen to influence central banks. And the notion that GDP growth should be prized above everything else is no longer the case for politicians nor the public either.
“The reality is human beings crave more than GDP. It is not actually what matters most to them. They crave identity and purpose and meaning. Both the vote for Brexit and in the US Rust Belt [for Trump] showed that voters are saying the golden era of business has not worked for many people in the skilled working and middle classes in the West.
“And in Hong Kong people are protesting both at the threat to their freedoms and [at] many of the same material distortions we see in the West, sky-high property prices being one. The muscle memory of political rights in Hong Kong presents a challenge to the [mainland] Chinese policy of giving enhanced prosperity to people in return for no political rights.”
Timing markets is impossible, says Chartres, but these tensions will inevitably bubble over, making it important to be positioned before that becomes the case.
What is the biggest single error in current market pricing?
Interest rates by far. The mispricing of interest rates means everything else is mispriced.
Will sterling be closer to $1.50 or $1 in 12 months’ time?
Minus a crystal ball, no idea. (I would guess $1.50.)
What is the percentage probability of a UK Labour government in the next five years?
Official answer 35%. (Assume an early election – government unlikely to make it to 2022, as majority now one, so two elections ahead.)
Will London have a higher, or lower, GDP per capita in five years’ time?
Higher, definitely. (Brexit kind of irrelevant as this country will remain free, open and business-friendly.)
What single asset would you short over the next five years?
Corporate credit. US investment grade five-year. (We don’t directly short at Ruffer but have positions that go up if corporate credit implodes.)
What is your ‘desert island’ book and luxury?
Book: Winston Churchill’s A History of the English-Speaking Peoples. I’ve always wanted to read it.
Music: Elgar’s Enigma Variations.
Luxury: Is this the point where I say a subscription to Property Chronicle magazine?
