Market sell-offs can provide the chance to buy quality assets at attractive valuations. Of course, if you can preserve capital as prices fall, then you’ll be better placed to take advantage of any opportunities that arise.
We see the recent falls at the long end of the US bond market as an opportunity worth grabbing.
In a world full of uncertainty, if you were offered a return above inflation of almost 2% for the next 30 years, with no default or deflation risk, and in a sovereign, dollar-denominated asset, wouldn’t you be tempted? We are, and long-dated US bonds are the one asset that has lured us out of cash.
We think inflation is close to peaking, and bond markets could be the first to sniff out a Federal Reserve pause. Adding TIPS (US government issued inflation-linked bonds) also provides the chance to diversify our inflation protection – and to make money should tightening pressures ease. In fact, it’s hard to imagine a scenario in which equities can rally without a move in yields first.
Two-way bet
That makes these bonds a two-way bet: a money-making opportunity if the Fed does pivot or pause, and an asset that could provide some protection in a recession, when bond yields tend to fall.
But hold on, discussing peak inflation feels like a big moment for a strategy which is synonymous with concerns of higher inflation.
Our view remains that we are firmly in a new structural regime of inflation volatility, and the recent actions of governments and central banks have only reinforced this view. However, shorter term, we can foresee inflation falling and recession risks continuing to rise. As a result, we have positioned the portfolio to navigate an environment where rate hikes will slow or even pause in the next few months.
At the Covid nadir, the severe dislocation in the TIPS market gave us an entry point to participate powerfully in the subsequent summer rally, without needing to add to equities. Having preserved capital over the first quarter of 2020, we could take opportunities when others were taking cover. This is the true value of an unbenchmarked, unconstrained strategy: the ability to look at investments through a different lens and find the most appropriate way to add risk in the circumstances.
Ajay Johal is an investment manager at Ruffer
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