Bonds  

Bearish trust managers turn to index-linkers as inflation defence

The managers of the Ruffer and Capital Gearing investment trusts have said their sizeable index-linked bond exposures will act as an imperfect but useful hedge as higher inflation begins to feed through in the UK and the US.

The UK’s decision to leave the EU has seen the pound's value slump this year, raising the prospect of higher prices. Higher inflation is also a likely consequence of the fiscal stimulus policies expected to be unveiled by both the UK and the US in the coming months.

Donald Trump's imminent arrival as president of the US has sparked a "reflation trade" in markets, bonds selling off in expectation that fiscal as opposed to monetary loosening will come to the fore under his presidency.

Ruffer Investment Trust co-manager Hamish Baillie, whose portfolio includes a 12 per cent allocation to long-dated index-linked bonds, said that Mr Trump’s economic policies look “pretty reflationary”. That should provide a boost for index-linked debt - but only in time.

"Trump’s economics are pretty reflationary, which short-term will be negative for long duration assets [such as index-linked bonds] but positive for some cyclical plays. Longer term this will increase inflation and see real yields fall, which is good for index-linked bonds.”

Another longstanding bearish manager, Capital Gearing Trust chief executive and co-manager Peter Spiller, cited inflation as the biggest risk to his portfolio.

He has allocated 15 per cent of his trust to index-linked bonds, and believes their benefits can offset the risks involved in holding an asset which is closely correlated to ordinary government debt.

“This is one area where we are trying to be clever in that it’s very clear that the correlation between index-linked bonds and conventional bonds is very high. Even if the reason why the reason the yield curve is steepening is because expectations of inflation are rising, you would think the breakeven on an inflation-linked bond would compensate for that.”

“Today we have never been more defensive, and our assessment is that all asset classes have been driven up by the monetary background to a level where the potential returns are very moderate,” Mr Spiller added.

Mr Baillie, meanwhile, agreed that an inflation spike was the “greatest risk” for investors.

“The greatest risk that Ruffer sees to savers’ capital is a return of inflation. Central banks and governments regard a little inflation as a desirable, and relatively painless, way to reduce debt burdens since it reduces the real cost of borrowing over time, but as long as interest rates remain at zero then savers are being robbed to fund the bailout.”