The crisis in the eurozone, the stasis in the rest of the developed world and the build-up of inflationary pressures hamper investors’ quest for sanctuary as the number of “safe” asset classes dwindles, writes Helen Burnett-Nichols.
For years, investors looking for the safest place to put their money during uncertain times have turned to the old stalwarts – cash, government bonds and even gold – asset classes that were deemed to be inversely correlated to risk assets, and for the most part, offered reasonable returns.
But as the fallout from the financial crisis and the difficulties in the eurozone continue, central government actions, credit rating changes and volatility have meant that those assets considered risk-free are dwindling. Indeed, some market commentators say the concept of a haven asset no longer exists.
“The universe of AAA economies has obviously dropped by 70% over the last year. And we have lost a number of prominent former luminaries of the safe haven,” says Stuart Thomson, a chief economist at Ignis Asset Management.
Indeed, say managers, although global havens seem to be falling one-by-one, there has been an acceleration in the past few months. (Cover story continues below)
In a move affecting one of the most traditionally sought haven assets, Standard & Poor’s (S&P) lowered its long-term sovereign credit rating on America from AAA to AA+ in August, broadly reflecting the ratings agency’s view at the time that “the effectiveness, stability, and predictability of American policymaking and political institutions have weakened at a time of ongoing fiscal and economic challenges.” France and Austria also lost their S&P AAA status earlier this year.
Add to this the fall of the Swiss franc – a haven currency – last summer when the Swiss government offered an unlimited amount of francs pegged to the euro, and perhaps the last remaining haven asset, the Japanese yen, which has broken in the last few sessions, explains Tom Becket, a chief investment officer at PSigma Investment Management and the manager of the PSigma Dynamic Multi Asset fund.
“Last year, the Swiss franc was a safe haven until the day it wasn’t, and that was absolutely another sort of coffin in the theory of safe haven asset classes,” he says.
”The key to the death of the safe haven has been the added liquidity that’s been pumped into financial markets by central banks and governments around the world”
“So far this year, perhaps one of the most important trends that we’ve seen in markets has been the recent tear-off in the performance of the yen, says Becket. With the yen now back up to 80 against the dollar, and up to about 126 against the pound, you’re really starting to see the yen fall out of favour as a safe haven currency for valid reasons in the sense that it is not a safe haven at all,” he adds.
Fluctuations in property values, particularly in America, have also dented the notion that bricks and mortar will always be a safe investment. Meanwhile, a volatile gold price has, for some, undermined the yellow metal’s position as a store of value in the shorter term.
The recent fall in the number of AAA economies has served to underline the shrinking supply of safe collateral, explains Thomson.
“Since collateral is the lubrication of the world’s financial markets, it does show that that’s an important reason why the level of trading activity in these financial markets has slowed. The other aspect of the shortage of safe havens is that it’s an indication of the excess global savings in the world,” he adds.
“I think the key to the death of the safe haven has been the added liquidity that’s been pumped into financial markets by central banks and governments around the world,” says Becket.
For many managers, the difficulty in finding a haven comes as no surprise, with the American, British and European central banks buying government bonds through quantitative easing (QE) programmes.
“The whole point of monetary policy, at the moment, is to force people out of cash, where they wanted to go out of fear and savings and so forth, and force them to take risks. That’s the whole point of it. So it should be no surprise that what are normally lower risk assets are not as attractive,” says Martin Perry, the manager of the CF Heartwood Defensive Multi Asset fund, which was recently launched as part of a range of multi-asset funds.
This has left investors with three investment choices, says Becket: those that are risky, which he says includes the majority of financial markets, perceived low-risk assets, which he says have become inherently risky, and third, cash.
“Any of the safe haven asset classes of the past are probably no longer safe havens, which makes the job of an asset allocator difficult,” says Becket.
In early 2012, the prevalence of low-yielding government bonds has led some asset managers to tactically move towards riskier assets.
The Bank of America Merrill Lynch February survey of fund managers noted that 26% of asset allocators were overweight equities that month, up from 12% in January, with appetite for cyclical stocks rising.
”Lots of investors moved money into inflation-linked gilts and the return on those is not looking so attractive in the short-term”
At the same time, fears over the European debt crisis persist for many investors, and managers say the popularity of perceived haven assets, namely US Treasuries and UK Gilts, continues.
“When S&P downgraded the US, the price of treasuries rose, completely in reverse of what should have happened. Despite the fact that you had a ratings agency saying the US was more risky, the markets treated it as less risky,” says Adrian Lowcock, a senior investment adviser at BestInvest,
In its global forecast summary for March 2012, the Economist Intelligence Unit notes that 2012 will be an “unsettled year” for the global economy, with further delays to what it says has already been a slow recovery from the recession three years ago.
“In addition to the challenges facing Europe, the US economy remains in poor shape by historical standards, despite a stream of improving indicators; with petrol prices rising again, consumer and business confidence could easily fade,” says the report.
“In the darkest hours, when you’re looking for ’the safest havens’, it tends to be the United States, it tends to be the UK and if we are going to revisit some of those dark places where we were last year, then I would imagine that it would continue to be UK Gilts and US Treasuries,” says Andrew Cole, the manager of the Baring Multi Asset fund.
At the same time, as at February 29, 10-year index-linked gilts were yielding 2.19%, with annual inflation sitting at 3.6% in January. In America, the 10-year Treasury was yielding 1.98% on February 29, with inflation at 2.9% in January.
On March 1, Towers Watson, a professional services firm, downgraded intermediate (10-year) global government and intermediate inflation-linked bonds to “highly unattractive” relative to a cash benchmark, with a view that “ongoing money-printing by central banks and flows into so-called safe assets have pushed intermediate bond risk premiums to low levels that no longer properly compensate long-term investors for taking duration risk”.
The firm also notes that, according to its research, in the next year, deleveraging, easy monetary policy and flows into “so-called” safe bonds are likely to keep bond yields and bond risk premiums low.
“I’m always a little bit wary about the use of the term ’a safe haven’. We tend to think about government bonds and cash as being the safest investment destinations and yet, in recent years, we’ve learnt that government bonds, particularly where you have some element of a debt crisis, may protect you in, to some extent, nominal terms, but not in real terms,” says Cole.
Although its rating has been downgraded, America still retains its haven status in the eyes of many investors, as a result of its reserve asset status.
But while many people also perceive the UK gilt market to be a haven asset class, especially in the second half of 2011, John Pattullo, the head of retail fixed income at Henderson Global Investors, has some concerns.
He says: “What worries us longer term is the extraordinary amount of government gilts that are being bought by our central bank, which are being issued by our central bank. Quantitative easing will be at least £325 billion, which we estimate will be 36% of the gilt market and at some stage I think that just seems a bit too much.”
Although the lower UK inflation figures were well expected and anticipated, says Lowcock, they are changing the outlook of some of the inflation assets and particularly index-linked gilts, he says.
“The issue there is that because everyone’s seen them as a safe haven, and because they’re always concerned about inflation, lots of investors moved money into inflation-linked gilts and the return on those is not looking so attractive in the short-term,” he says.
”Gold has always been considered a store of value, but it fluctuates incredibly”
Patrick Armstrong, a joint managing partner at Armstrong Investment Managers, warns that the assets considered by many investors as havens are moving into bubble territory.
“Our thesis is that whenever there’s an equity crash, there’s an asset class that survives that crash very well and inevitably, it turns into a bubble itself,” he says.
“Historically, bonds yield at least 1% more than inflation over a cycle and now they’re several percent below. So I think over the last year they’ve been moving from overvaluation to bubble-like characteristics. The characteristics are that people make excuses that although this doesn’t make sense as an investment, there will be a reason why it makes sense right now. [The result is] you have massive allocations to these asset classes and extreme fear and risk aversion among the broad investor base.”
Part of the broader problem, says Thomson, is that excess savings globally have produced imbalances, of which only one side is trying to correct itself.
“Only in the deficit countries are they trying to increase their savings, trying to reduce their deficit, borrowings and debt.
“On the other side of that equation, we’re not seeing the same drive towards reducing savings in these surplus economies and that’s what gives us this weak and volatile growth which, in turn, maintains a demand for safe havens,” he says.
Meanwhile, although gold’s portability and physical nature have historically led it to be considered one of the ultimate stores of value, this remains a point of debate in early 2012.
“Gold really fell as a safe haven asset class towards the end of the third quarter, when the gold price fell 15% in a matter of a couple of sessions, and people took profits and people realised that it was no longer a safe haven,” says Becket.
Gold ended 2011 up 9%, but swung significantly in the second half of the year. So far in 2012, the metal has gained about 10%. The World Gold Council reports that in 2011, demand for gold bars and coins climbed 24%.
“Gold’s always been considered a store of value, but it fluctuates incredibly. And therefore, I think it would be wrong to say it’s a safe haven. It is a store of value long-term, yes, because you can’t print more. However, it is a volatile asset and again, in the short-term, you can get caught out by 10%, 20% movements. Is that really a store of value if you can lose 20% in three months? Arguably not,” says Ben Yearsley, an investment manager at Hargreaves Lansdown.
But although gold has become more volatile and more susceptible to speculation, it still does have many of its haven characteristics, says Lowcock. For example, if equity markets rise, the gold price tends to fall off and vice versa.
“There is more speculative access, more easy access into gold and therefore you may see more volatility than historically true for that asset class. But it still has its safe haven status at the moment,” he adds.
Falling government bond yields point to the fact that there are few, if any, alternative havens for investors.
“I wouldn’t say [gilts are] the safe haven of choice, they’re the safe haven of necessity, rather than the choice, because there’s not a lot else”, says Yearsley.
So, is the concept of a haven asset a thing of the past? Managers say there are alternatives that provide investors with more protection than traditional havens, with better returns. However, many are hesitant to call them “safe” in this market.
Interestingly, for many managers, it is the slightly riskier asset classes that provide safer opportunities than government debt and cash.
For PSigma’s Becket, who says he holds no conventional government bonds, a relatively safer opportunity lies in the corporate credit markets.
“If you think about what you can get from a five-year US Treasury, about 1%, juxtaposed against the 7% you can probably get from a collection of high-quality corporate bonds,” he says. “I think you’ll be adequately compensated for taking that risk.
“Perhaps not a safe haven asset class, but perhaps a predictable return and a much higher return on offer than there are from what used to be the safe haven asset classes of the past,” he adds.
Pattullo notes that multinational companies – Unilever, Procter & Gamble and Vodafone, for example – can be considered safer either on the equity or corporate bond side, as they are less levered than the sovereign they reside in.
“Lending to those entities, whether buying the shares or buying the debt, is probably safer than lending to the governments,” he says.
Patullo invests in the middle of the curve, with a mixture of BBB, BB and B, with a big bias towards non-cyclical large businesses and not much interest rate risk. This, according to Patullo, is because gilts are too expensive, and CCC and cyclical high-yield businesses are too risky in a low-growth economy.
Indeed, the IMA reports that UK Corporate Bond was the best-selling sector in January, seeing its highest monthly sales since August 2010.
For Heartwood’s Perry, the ideal protection for anyone seeking lower risk continues to be diversification. Although his fund has a high cash allocation, it is also exposed to global equities and a mixture of index-linked government bonds, short-dated conventional gilts and investment grade corporate bonds. He also holds quoted commercial property vehicles and a small amount in gold.
According to a recent report by Melissa Kidd, a research economist at Lombard Street, while the greater volatility of equities relative to bonds means they need to deliver a premium to investors, “the stretched yield gap between equities and gilts in the UK could easily pay for this”.
“With the UK equity market yielding 3.9% more than 10-year index-linked gilts, equities need only deliver an extra 1.1% in capital growth to pay for their extra risk,” she notes.
The risk-reward trade-off is even better when it comes to defensive sectors, according to Kidd. She says several of these could deliver negative real annual growth and still be a better bet than gilts.
“Taking a more short-term view of risk brings home the point that some sectors are “safer” than the UK sovereign, but offer better yields,” she says.
”Lending to those entities, whether buying the shares or buying the debt, is probably safer than lending to the governments”
Armstrong agrees. He suggests that high cashflow, high dividend paying stocks, are relatively safe. “I just don’t want to go as far as to call them a safe haven,” he says. But we think that’s where investors will rotate to, because you’re getting yield significantly above inflation, the ability to participate in any economic growth if it does occur, healthcare stocks fit that bill very well.”.
“In the short-term they’ll be more volatile, but over a five to 10-year holding period, these will perform much better than government bonds, which are almost assured to destroy purchasing power over time,” he adds.
For some managers, however, the inherent risk associated with equities still stands in the way of their being considered a true haven for investors.
“In terms of equities, yes, you can look at the quality international global multinationals, but they’re relatively expensive. There’s no obvious place to hide, there’s nowhere that’s providing security yet is inexpensive too,” says Perry.
“I think you have to be selective in your investment principles with regard to defensive equities being a safe haven. But perhaps the more interesting long-term point could be that the bonds of companies of the ilk of high quality US companies, and indeed their equities, could well be safe haven assets of the future,” says Becket.
While, for some, equities may represent a safer alternative, Mike Turner, the head of global strategy and asset allocation at Aberdeen Asset Management, notes Asian currencies are probably the only area with some sort of systematic appreciating trend, and could be seen to be improving as a haven.
Although an improving credit status for countries in Asia and the emerging world sits in contrast to the problems with the creditworthiness of traditional core sovereigns, such a transition is still years away, says Turner. In particular, he says Singapore has allowed its currency to revalue up against the dollar and seems to be strong, in a fundamental sense, from a credit perspective.
“I think it is something that’s interesting to point out about the safe havens of the future – they may not be within the developed world as we know it,” he says.
In addition to the renminbi, other Asian currencies are expected to strengthen over the next decade or so, says Lowcock. But he also does not expect them to take over as havens imminently.
“Many Asian countries are quite robust and their governments are financially secure, but it will take a long time to replace a haven currency or haven government treasury, because countries like Germany and the UK and America have built up strong reputations over many years,” he says.
In the meantime, seeking shelter may not be an easy task for investors. However, It is one many seem reluctant to abandon – although some commentators say they may be better off doing so.
While in general, the prospects for return from havens are poor, Turner says the idea of a sanctuary has to do with risk mitigation.
“I don’t think people are necessarily going to sell out wholesale because the return is poor. It is there for risk mitigation purposes, so if things come unstuck or unravel, macroeconomically, politically, then they have this balancing item in their portfolio that would possibly do them some degree of good,” says Turner.
But Armstrong warns that eventually, investors will get frustrated with returns coming in below inflation from perceived havens, which will trigger a transition away from these assets.
“We think all the actions central banks are taking will inevitably be inflationary and then the savers will be punished. All the quantitative easing that’s happening in the world is designed to create inflation and provoke investors to move out of the safest assets. It is a very dangerous game to be fighting the Fed,” he says.