#61 - Jonathan Ruffer: Financial History, Market Cycles, Outlook

0:05Welcome to the Insightful Investor Podcast, a weekly series that seeks to share industry, investment, investment, and market insights. We define insights as concepts that are counterintuitive, widely misunderstood, or underappreciated. In other words, unique ideas that you probably won't hear elsewhere. I'm Alex Shahidi, the host of the podcast and co-CIO of Evoke Advisors, a leading investment advisory firm. Learn more about our show at insightfulinvestor.org.

0:38I'm delighted to welcome Jonathan Ruffer to the podcast today. Jonathan is the co-founder and chairman of Ruffer, a London-based investment manager focused on generating absolute returns for its clients. Jonathan, thank you for spending some time with us today. It's a great pleasure, Alex, to be with you. Well, Jonathan, you started your career a little over 50 years ago, but do you feel that investing has always been a core part of who you are? In a sense, do you feel that you were born an investor? It's always rather hard to know the answer to that sort of question, But I do remember my dad gave me a book, which in retrospect must have been about how to invest via charts, because the idea of following Diners Club, which is the stock that was used in the book, absolutely stuck with me.

1:32And throughout my life, although I'm not actually very interested in investing via charts, that idea appealed to me. And I must have been about 11 years old when that happened. Well, you are a dedicated student of financial markets history. What do you feel sparked your deep interest in studying the past? Well, I think there one can talk more about the way one's made. To me, the fascination of history is its stories. And I find that the best way of grasping the essence of something is that if you can tell it or hear it through a story, it lands more vividly than something theoretical. and when you're investing, you don't really want to be dealing with fairy tales.

2:30So from an early age, I've wanted to understand the present through things that have happened in the past. That is fascinating. And I think something that's interesting about what you just said is the stories are always unfolding. And even when you're living through the history that we're creating today, it's hard to envision how that story is going to be told in the future. So part of studying the past is looking at the past through the stories that are told after and then trying to relive it real time as you're going through it. One of the things I was thinking when I was walking over today is that Britain lost Singapore in 1942 in the sweep of Japan's conquest of Asia.

3:20And a decision was made in 1924 when Britain was rather strapped for cash, not to reinforce it, not to bring it up to date. and I'm thinking to myself well that was 18 years before what mistakes were we making 18 years ago that we're paying the price of today so to speak there's nothing magic about 18 years but this idea of a period of time seems to me to be the way to get the feel of how people's memories mature on things that were perhaps a complete non-event when they happened, or perhaps an amazingly big event, but turned out not to be such a big event. These are the things that fascinate me.

4:14If we shift to what qualities make up a great investor, you've obviously hired a lot of smart people to surround yourself with to allow you to be a great investor. Are Are there any specific qualities that you look for? I think that the way I want to answer that is to talk negatively. You need to be clever, but you must, if you have a self-image of yourself as clever, you'll go wrong.

4:52some buffoons said that when you make an investment when you've done all your homework you're probably looking at six percent of all the relevant facts which will determine whether it's a good investment or not now if you're a clever clogs and you know you're a clever clogs and you're a lot of pleased with yourself you can probably get that six percent to ten percent but you know who wants to be leading with the chin with something where the uncertainties are 90 % and the certainties are 10%. So poverty of spirit is quite an important element. And I think above all, a sense of maybe. I always am on edge when people tell me that the new administration will be a success.

5:42Yes, that will is the word which doesn't land well with me. Everything in life is a maybe, and investment is made up of maybes. Yeah, so I guess another way to summarize what you just said is, if you're really smart, maybe you're at that 10 % level. And the key is that you recognize that it's 10%, not that you're too smart for your own good where you think it's 90 % when it's actually 10%. That's exactly it. My dad, I'm talking a bit about my dad, but not for any particular reason, but I remember him telling me, we were driving in the car one night, and on the road, there was a roadkill of a hare, which had been hit by a car.

6:32the hare knows that it's the fastest animal in the region and so it will always try to run away from danger so the car hits it whereas every other animal will chink to the side because it knows that it's not that fast to run and it seems to me that we don't want to be hares because we'll be hit by that 90%. Yeah, and I suppose part of that is also informed by your actual experience. So if you start off as an investor, and the reality is you have 10 % of the information, but if the first five or 10 investments hit, you could easily become overconfident because you attribute skill to what was actually luck.

7:21Yes, I guess that's right. But, you know, you get pummeled so much in the investment world that I think it's the failures that one remembers more than anything else. It took me some time to work, to articulate it to myself. But I've got two characteristics that really shouldn't coexist. I'm risk averse and it always amazes me when fund managers make a boast of being risk averse to me that's like being a fighter pilot and saying that you're a coward if you're a coward become a librarian if you're risk averse why are you taking on risk so I tell you that as a confession I am risk averse but I've also got within me an absolute compulsion of taking risk, manic risk, you know, the sort of risk that one wouldn't even admit to one's dentist.

8:33And these two qualities play like orangutans within me, you know, the compulsive side saying, oh, go for it, At the other side, you're not sure about that. And that's really why I landed on the way of investing to take real risk. That's the orangutan of compulsive risk-taking. but to do it in such a way that you were using your skills and you were using the elemental risks in the market to try and never, never, never to lose money. If you think of a good investment, it's a commonplace thing to say, But really, investment is about optimizing upside risk and minimizing downside risk. Now, effectively, what we're trying to do is to optimize the upside and minimize the downside, but with the emphasis on minimizing the downside.

9:57such that we wouldn't lose money in risk markets. And the fascinating thing was that when we started the business in 1993, people said it is not possible. I mean, they didn't know about Ponzi in those days, But I think they would have said if they had done, at least Ponzi sounded like he'd got a good idea. You've just got a bloody awful idea because it can't be done. And the thing that makes it possible is the fact that if you're playing the roulette and the engineering's wonky, so some numbers come up more than they should, and the croupier's drunk, so he's declaring the odds wrongly, it's those two facts that become the decisive element in making investments.

10:57And I mean, to be honest, I think it was a flu, but for two and a half decades or more, we actually didn't lose money, at least in a calendar year. And then everybody thought, gosh, not only is this doable, but it's culpable not to do it. And, of course, that brings problems with it then because everybody thinks that if you have a year or, as we've just had, two years of not making any money, they think that somehow or other it's not the model that's wrong. It's there's something wrong with us. And, you know, the fact is that we're in a constant firefight and that's just the way it is sometimes.

11:49Yeah. And I guess if you go back to what you said earlier, which is being risk averse and being a risk taker at the same time is very similar to knowing that you're in the six to 10 % and being skeptical that you don't know a lot. And those two kind of states put together force you into a discipline of, I'm going to take risk where there's a lot of asymmetry. There's a lot of upside potential, low downside risk. And I'm going to look for those unique opportunities. I'm going to do a bunch of those things. And then you can effectively take risk, but it's like a calculated risk as opposed to just a risk that has kind of equal upside and downside.

12:27That's exactly right. And of course, they always say that being a market timer is the key to investment. Well, I've been operating this formula to the 40 years of the biggest bull market that has existed since Marcus Aurelius. So in other words, I've been driving with a handbrake on when actually what you wanted to be doing was listening to John Bogle, who was saying, take all the risk that you can, and just if you can shave a hapenny off the fees, you know, that's what will make you better than average. So the result is that ETFs now rule the world. and the rougher patent medicine is still in its infancy, I think, Alex, is how I'd put it.

13:27Yeah, and when you look back 20, 30 years from now and the story of the current environment is written, it's going to be something to the effect of best companies in the world, the market just keeps going up. Anytime it falls, you just buy and it rebounds. And that story can easily change. You could easily go through a 20-, 30-, 40-year period where you don't have that. And that story would be very different. Absolutely. And the great thing about making forward-looking observations is that you can't say to me, Jonathan, I'm sorry you're wrong about that. But I fancy that the extraordinary thing about the last 40 years is we haven't had a bear market.

14:16What we've had is a constantly rising market punctuated by collapses, by crevasses. And that's really what stopped the market going up from nothing to the moon. but if you look at the amount of time that the market's gone up since 1992 it's really been a high percentage of it and what I think could easily happen for the next 3, 5, 10 years whenever it starts is that it will be a constantly falling market punctuated by, is it stalemites, you know, the ones that go shooting up. So you can't just operate on the bear tag because you will suddenly be confronted with the market doubling as it did in January 1975.

15:16So I don't think for us that next phase will be any, it'll certainly be easier in the sense that we will be directionally in sympathy with the idea that markets can go down. But I think we will be able to be caught out just like the next man from these sharply rising expressions of ebullience. So another, I think, key component to investing is just your intuition. Are there some things you've discovered through trial and error to be incorrect about your intuition that you have now adjusted? One of the striking things, which I would definitely call a weakness in the way I invest, is that I have never, never, I don't think, had properly invested in a company which went from being a little one to a big one.

16:28I've honed my skills, and I'm nicely arrogant about how to buy stocks. But sooner or later, particularly if they were well bought, I tend to see the sale of those stocks as the vindication or otherwise of the purchases that I've made. And what it does mean is that, you know, in new industries come, the magnificent seven happens, and I've been innocent of all those stocks. I've traded in and out of them. But when I'm a trustee of a lot of old family portfolios, and what strikes me when I look at them is you usually find that they bought GlaxoSmithKline at a hundredth of what it's worth now, Shell Oil at a hundredth of what it's worth now.

17:31Yeah, sure, they've owned them for 40 or 50 years, but actually, I strongly suspect that those decisions never to sell fine companies has taken their performance beyond what I've done. Yeah, and that's obviously a byproduct of this bull market age that we've lived through for several decades. Yeah, yeah. The other thing that I think is interesting about investing is that there are components of it that are deceptively simple, and many people tend to overcomplicate them. And at the other end of the extreme, there are aspects that are incredibly complex that are prone to oversimplification. Do you agree with that?

18:18I think that is right. One of the things that I've pondered is the way that investment has professionalized and not to its advantage. I have, I think, the perfect cerebral makeup for investment. I've got a quick mind so I can pick things up almost instantly I've got a great imagination so I can make connections straight away that other people can't make and I'm stupid now it sounds like I'm paying myself two compliments and dissing myself on the third But there's a great advantage in being unable to understand what other people, what other class acts can understand, because it keeps it simple.

19:21I never read, I don't think I've ever read the whole of any Fed governor's statement, mostly because I can't understand them, and partly because they're boring. But it was in the middle of the 19th century that the discipline of political science changed from being people -watching to mathematical. And the thing about it being people-watching is that that becomes open to everybody. but the moment you introduce the element of mathematics it is really only open to a cadre of people who can understand the mathematics and one of the things, I talked earlier about Singapore but there was the Battle of Chutland when the Germans and the Brits knocked seven bells out of one another in the North Sea it was a sort of defining naval battle in the First World War And the Germans turned out to be rather good at gunnery.

20:39They were quite accurate. And the Brits turned out to be perfectly hopeless. And the reason I reckon for that was that the Navy was only open to gentlemen. So you had to be a Tufton Buffton to be able to join the Navy. And when gunnery came along, gunnery was rather messy, and that messed up your nice white gloves that you wore as a gentleman. And so you didn't do too much practice. And the people who were good at gunnery were considered not really the sort of people you wanted in the Navy. So what you had was an irrelevance getting in the way of effectiveness. Now, I think that's what the maths, you know, all those zooms or whatever they're called, those sort of e's that look like they've been lying in the sun for too long.

21:40I think what they do is they keep real investors from having the confidence to see that investment is really little to do with these questions. Bonomi Price, who was the last proper political scientist in the way that I think of it as a social discipline, he described economics as elevated common sense. Now, that feels to me spot on. It's not enough simply to observe how people behave. You have to take that raw material and spend a lifetime working out what that means in the investment world. And doing it through the prison of history is the way that I've done it. And everybody who works at Ruffin at least pretends to pay lip service to that one.

22:42And along the same lines, do you see investing as both a science, you know, an engineering or math-like exercise and an art that's rooted in investor psychology? And I guess these two elements interrelate and contribute to the complexity and predictability of markets. I would say yes. And I would say that the science is to do with short-term performance and the soft EQ applied, the elevated common sense gives you the long-term edge. And I covet both. So no man has all the elements that you want, or if they exist, I've never met such a person. but I think as a group you can find that and it also helps the humility because what you can see is people with qualities that you not only are not your strengths but you might not even have at all that's how you can you can build you can see a team built I wouldn't say I built a team but And that's how a team gets built.

24:07We talked about generating returns while minimizing risk. And returns are easy to see. You can see them every day. But risk is often invisible, yet it's ever-present and it quietly builds over time. And I guess paradoxically, the longer it remains hidden, the greater its potential impact becomes. Do you agree with this? And what's your general perspective on risk? Well, that was the only thing that you wrote, which I actively disagree with. It seems to me that the only reason that the risk seems to grow is because it only grows like that in a unidirectional market. So, I mean, one of the people we discovered earlier, he's now better known, was Hyman Minsky.

25:05And the Minsky moment when the sand that goes through the egg timer has formed a little hill that it then collapses. And the more prominent that hill of sand is, the greater the fall of it when it does. So I think it is absolutely fair to say that when this market goes, it will be an extremely colourful one, not because of the fact that Germany has got an election or things are happening in Colombia that shouldn't happen in Colombia, But simply because the world has grown into the shape it has is because we haven't had a setback that has allowed to be a setback. I mean, my own feeling is that 2008 was a proper game changer, and the authorities simply used their balance sheet to create a more powerful dynamic on the other side.

26:36And in the short term, if 15 years can be regarded as a short term, they've got away with it. But it's left all the imbalances greater in Minsky language than they were in 2008. And that was bad enough. So let me ask you some questions about financial market history, because you have this very zoomed out perspective of looking backwards over a long period of time across countries. But if I ask you to look forward 50 years into the future, are there any timeless principles you feel will endure? And what aspects of the world do you feel might fundamentally change? I think one of the mistakes that people make is that what happened yesterday will probably happen tomorrow.

27:27What happened last year will probably happen next year. And that isn't so. I think the shape of the vehicles that we invest in will change enormously. I think equities are finished. Now, why do I say that? The cult of the equity is pretty young. It's a post-war phenomenon. And it isn't that before that equities were not important. But the reason you were in stocks and shares was primarily either to own a business or to control the business. So that was where you went if you were in the business of controlling it. And if you were trying to make an investment, what you wanted to do was to find in a long list of quoted fixed interest.

28:41In Britain, you had debentures, unsecured loan stocks. You might have five unsecured loan stocks, which traded preferentially. then you'd have preference shares beyond that. And if you could find a company that you thought was more powerful than the market thought, you'd buy a junior tranche of the debt on a high yield and you would watch it trade up to a treasury yield. So that was how you got it. You were doing it for capital gain, but you weren't basically trading the equities. Now, when I think of a profit-making business, I think that there are four claims on that business. You've got the government who wants to tax it.

29:44You've got the workforce that, for some odd reason, wants to get paid. You've got the management who run the business. And you've got the shareholders who own the business. Now, if you put it like that, what you can see is that the shareholders have naturally two weaknesses. One is that they are spread among a great many people. So everybody has only a small fractional interest in the business. And they're sleeping. They don't have anything to say. I mean, if you said that to Elliot, I think he'd rather disagree and say he's got quite a lot to say about the running of business. But basically, the position of an institution investor is to be a sleeper of a small interest.

30:43Now, that became transformed when managers decided to unite with the stockholders through stock options. So, you know, you get paid hundreds of thousands of dollars for your salary, but you get millions or tens of millions of return through your stock options. So those two together became more powerful than anything else. But I think that that phenomenon is basically over. You know, the growth in the private equity and private credit market is an indication that if you want to own the equity of a business, you need to have control of it. So the provider of private equity does that. They will own enough of a business really to be able to control it on behalf of their investors.

32:00So it's no surprise to me at all to see the health of stock markets declining sharply so that European bourses are too small to remain viable. you know, Canada and Australia aren't big enough really to have a say. And if you look at the American market, the dominance of the Magnificent Seven really tells you quite a lot about the undemocracy of the pool of corporations whose shares are traded on the market. So in my view, that what George Ross Gooby worked out in the early 50s, that equated a coming asset class, that was true for the period then. But now, 75 years on, I don't think the conditions, I don't think he discovered an eternal truth.

33:16I think he discovered a market truth, and market truths come and go. And I think equities are going to be not the place to be as we pull out of a bear market that I think will last quite a long time. Do you feel like that's a realization that the market participants will gradually observe and catch on? Or is it something that you hit a tipping point and all of a sudden becomes obvious to everyone? I think what will happen is that management will become increasingly, managers of interest will become increasingly different from the shareholders. I mean, the conglomerates in the 1970s, Charles Bluthorn, you remember him, Gulf and Western, Lim Tinko Voigt, LTV, these were enormous businesses.

34:18And what the guys running it realized was that if they did a value-destroying takeover bid and the business was twice the size as it was, the chief executive got paid more. So that's what happened in the 1970s. The quality of the businesses decreased, and it was only in the generations that followed that that that mischief, which had been done basically quite cynically, when I first started investing, maybe did invest in Germany, because the businesses were run for the management and the workforce. What was the point of the shareholder? There wasn't any point in the shareholder. So I didn't see this as a new phenomenon, and it's just a return to an old one.

35:17You alluded to the U.S. as being a global dominant economic power since World War II. How sustainable is that position and what historical lessons might inform our view of America's future economic role and perhaps the success of its stock market? I've thought a lot about this, Alex. What destroys empires? The Spanish empire in the 16th and 17th century never realized that it needed to build into its model commercial success. So it sort of became a sort of heap of scrap metal really and filled it under its own weight. What Britain discovered was that the empire that it created, which was not dissimilar to the Spanish one, provided a different sort of excellence to commercial excellence.

36:29and that allowed really other nations to build past what the UK was doing. The UK felt very distressed. There were two great exhibitions, one in 1851, when absolutely every best invention seemed to be British, And 1867, which was only 16 years later, when they all seemed to be German or French or even American. And, you know, the confetti that had made Britain great had disappeared. Now, when one looks at America, it looks to me that it is past its sell-by date, but it's not yet clear to me what will bring it down. It's rather like looking at the sort of, you know, the chief lion in a pack of lions.

37:47You can say, you know, he's getting on a bit. That isn't quite the same thing as saying, and that's the lion that will replace him, or, you know, there'll be this or that. It's just an observation that the dynamism, that creative dynamism, which drives nationism to great things, seems to me to be becoming shadowy. Now, that's a fairly discursive answer. So I'd be more confident that being a bear of America, taking a 20-year view will be a right one than being able to put any cogent course, which would confirm that. Yeah. And I think that is, it's a very important insight because in my experience, amongst investors, there is this underlying assumption, even if it's not stated, there's an underlying assumption that US companies are the dominant global superpowers economically, and they're going to last forever.

39:06And so you just buy the S &P 500 and you hold on forever and you're good. And you don't have to worry about an extended period of underperformance or anything like that. That's just a general sense. And you've described a couple of things. One is US dominance may be on the other side of its arc and heading down and that may be gradual until it speeds up. You've also pointed out this whole notion of just don't assume that stocks for the long run is a truism. That could not – that can change. So there's multiple factors. And that kind of goes back to what we started with is that 6 % to 10 % of what your intelligence might know, there's a lot that is out there that can become a negative surprise.

39:54Yes. I must say, Alex, when you put it as bold as that, I do it if I'm wrong. I mean, I tell you one of the things that struck me from how this conversation is going is that I believe that valuations are the key to good or bad investment more than the comparative success or failure of the underlying investments. So that I read an investment review about three months ago when I said, you know, what's happening in the markets now feels like a combination of two things, the dot-com boom at the turn of the century and the nifty-fifty boom of a generation before that. and the thing that caught the dot-com boom out was that people bought the wrong companies.