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Article | 20 November 2019 | Investments
Safe haven investments should in theory keep or even increase their value when markets are turbulent. These assets are typically held in order to limit exposure to losses in market downturns. However, their safety can come at a price, as safe haven assets can be expensive. The high price you can pay for protection in traditional safe havens is a risk in itself.
The market environment
Since the financial crisis in 2008, higher risk assets have been performing strongly. As a result, safe haven assets have often been overlooked. However, they’ve recently shown their mettle. In the summer, stock market volatility began to rise. Investors rushed to buy government bonds and gold, so their prices rose as global equity markets declined, highlighting the protection safe haven assets can provide.
Safe haven assets have proven their value over the years, when it comes to protecting portfolios from volatile markets. So where should investors look for a port in the storm?
Traditional safe havens
High-quality government bonds, gold and cash are considered traditional safe haven assets. Here we outline the key facts for each of these assets, as well as the key risks.
High-quality government bonds
Bonds are generally considered less risky than their equity counterparts. And high-quality bonds such as government bonds have traditionally been sought in uncertain times. When held as a small part of a well-diversified portfolio, government bonds can provide some protection against a recession.
A key risk with these assets is, if interest rates go up, then the price of high-quality government bonds usually declines (bond prices often fall when interest rates rise). This could lead to investment losses.
Gold is viewed as one of the top safe haven investments. It has always been a ‘hedge’, an investment intended to offset potential losses in other parts of a portfolio, in tough economic times. This is due to its low risk and scarcity.
Gold’s downside, however, is its lack of income, as it can become relatively less attractive as interest rates rise. Moreover, the gold price can reflect how investors feel about global growth, which can make it a volatile investment.
Cash is considered the ultimate safe haven holding. This is because its returns aren’t impacted during market downturns.
Historically, you haven’t lost money when interest rates are very low, which is a benefit of holding cash. However, today we see negative interest rates from some central banks, most notably the European Central Bank. In consequence, some retail customers with large sums in their bank accounts are now, in effect, paying for the privilege of holding their money in an account. What’s more, inflation (the rising cost of living) can also eat into your returns.
Under-the-radar safe havens
Other types of assets are also often considered safe havens. Here we outline the kind of protection they can provide and their associated risks.
Examples of infrastructure assets or ‘real assets’ include wind farms and road-building projects. They’re low-risk investments because they are relied on by the population even in times of economic weakness. Infrastructure assets are often backed by governments and deliver a predictable income without the ups and downs of share price movements.
However, investors can often pay a high price for these assets’ perceived security and they’re not immune to market downturns. What’s more, there’s the potential for governments to nationalise these large-scale projects.
Defensive shares are stocks that move up and down in a narrower range than other stocks. They come from market sectors less affected by the underlying economy. For example, people need to use water and eat, even in a downturn. Companies meeting such essential needs look well placed for positive performance in any economic climate.
Defensive stocks are not, though, safe from market falls. They will often decline along with the rest of the market, particularly if these stocks are highly priced at the time of purchase. Moreover, defensive shares’ apparent protection can often come at a high price.
US dollar, Swiss franc, Japanese yen
Some currencies are preferred in uncertain times, most notably the US dollar, Swiss franc and Japanese yen. The dollar is the world’s most traded currency and investors often hold it as part of a flight to quality. The removal of the Swiss franc’s link to the value of the euro may make it a more effective holding in turbulent times. The yen’s safe haven status is partly due to its long-term stability.
However, currency movements can be large and unpredictable, while currency trading is a specialist area and ordinary investors might want to steer clear of it. The dollar’s safe haven status has been dented since the 2008 financial crisis. Japan prime minister Shinzo Abe’s economic reforms have lessened the yen’s safe haven status. Meanwhile, foreign currency purchases by the Swiss national bank have had a similar effect on the Swiss franc.
Better returns may come from higher-risk assets
Returns from traditional safe haven assets are generally relatively low, and returns on equities and corporate bonds are typically higher in the long term. For example, by investing in safe haven assets since the start of the 2008 financial crisis, you would have missed out on higher returns from shares and corporate credit. By investing in traditional safe haven assets, you risk missing out on potentially higher returns from other assets.
In contrast, some non-traditional safe havens, such as infrastructure and defensive equities, can participate in the higher returns from riskier assets. However, these investments don’t usually increase in value in times of economic stress, so some people may think they fail to fulfil the role expected of safe haven assets.
Smoothing market returns
Ultimately, investors hold safe haven assets to protect their investment portfolios. So, when equities are doing badly, a safe haven allocation can act as a safety net. Despite the high prices safe haven assets can sometimes command, they can reduce portfolio risk without necessarily reducing portfolio returns. We consider safe haven assets an essential part of a well-diversified portfolio: they can smooth out highs and lows in returns and help reduce investment risk.
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This Financial Promotion is issued by Architas. This is for professional clients only and should not be issued to or relied upon by retail clients.
AMML is an investment company that provides access to other investment managers’ services through a range of multi-manager solutions, including regulated collective investment schemes. AMML in the UK works with strategic partners and AXA Group internal fund managers, to find out more information about this please visit architas.com/inhousestratpartners/ AXA is a worldwide leader in financial protection and wealth management. In the UK, one of the AXA companies is Architas Multi Manager Limited, an investment company that provides access to other investment managers’ services through a range of multi-manager solutions, including regulated collective investment schemes. Architas Multi Manager Limited is a company limited by shares and authorised and regulated by the Financial Conduct Authority (Firm Reference Number 477328). The company is registered in England: No. 06458717. Registered Office: 5 Old Broad Street, London, EC2N 1AD.