Ruffer hedges inflation bets

Current economic uncertainty makes Ruffer Investment Company an interesting proposition, even though shares in the investment trust, which invests in a range of international securities including equities and bonds, command a premium to net asset value. The fund is particularly worth attention from prudent investors who are fearful that high, or even run-away, inflation will punish them while bailing out the profligate.

Following the European Central Bank's move to start quantitative easing, all major western economies have been, or are, in money-printing mode. What's more, with over-indebted governments increasingly being forced down the route of austerity, pressure could mount on monetary policy to keep economic stimulus alive. And, ironically, fears of deflation could persuade financial authorities to ignore signs of inflation as they struggle to ignite growth; the UK's stubbornly high inflation rate does not seem to perturb the Bank of England.

However, the Ruffer Investment Company is certainly alive to the prospect of substantial inflation in coming years and, correspondingly, negative real returns for savers. In order to safeguard investors against these perils, the trust has almost a third of its portfolio invested in index-linked government bonds.

That said, sustained high inflation is not expected to manifest itself this year. So while the emergence of inflation could be sudden, in the near term the trust's manager is focusing on a series of contradictory forces that look more likely to drive returns. On a bullish note, Ruffer expects underlying economic growth to remain firm and produce favourable surprises. Less positively, though, the manager describes China as "flaky" and "manifesting all the hallmarks of a seraphic over-exuberance". The prospect of contagion from the Greek crisis infecting the rest of Europe is also thought to be high, in much the way that a small amount of total lending to sub-prime borrowers had a devastating impact on the banking system.

Ruffer looks to generate annual absolute returns after all expenses of more than twice the Bank of England's base rate and its general mood over the short-term outlook is one of nervousness. The manager is worried that a wide range of assets will remain correlated following the global liquidity splurge and will head lower together as liquidity is tightened.

The key way the trust has attempted to reduce the effects of this risk is through increased exposure to the US dollar. Other recent moves by the trust included selling down a large position in BP shares ahead of the Gulf of Mexico calamity at prices between 620p and 650p, but the position was rebuilt after the share price fell, so exposure remains. Commodity-related plays were also recently trimmed. The trust has a big exposure to Japan, too, where the manager believes the authorities have been keeping their reflationary powder dry. That could mean significant upside for equities if action is taken.