Safety nets pose puzzle to investors

Investors have been left with an unpalatable choice for haven assets

Robin Wigglesworth

FILE PHOTO: An employee sorts gold bars in the Austrian Gold and Silver Separating Plant 'Oegussa' in Vienna, Austria, December 15, 2017. REUTERS/Leonhard Foeger/File Photo

The week when US stocks hit yet another record high may seem like a strange time to intensify thinking about how to insulate investment portfolios against a severe downturn. But, as consultants are fond of saying, by failing to prepare one prepares to fail.

Global stocks have been fuelled by easier monetary policy; hopes that the Sino-American trade war will abate; signs that the UK will be able to avert tumbling out of the EU without a deal; and the paucity of alternatives. Yet fund managers know that if any or all of those supports crumble, the usual protection could prove futile.

Historically, high-grade bonds have been the haven of choice for investors, repeatedly proving their mettle as a crisis-offsetting asset class. Today, bonds are so expensive — and yields so low — that their usefulness has deteriorated. Practical constraints limit just how much further yields can fall, which means that, although fixed income is still likely to help, it will not be enough to insulate investors from a broad bear market.

Certain currencies might offer ballast. The US dollar is the global reserve currency, and market stress has usually proven beneficial for the greenback. Stephen Jen, a hedge fund manager, coined the term “dollar smile” to describe the currency’s tendency to do well when the global economy is booming or bursting. Given the buck’s continued importance to the global financial system, this pattern looks likely to hold.

The Japanese yen is another popular safety-first currency, which some investors are now betting on. Franklin Templeton’s Michael Hasenstab doubled his $33bn flagship fund’s exposure to the yen to 40 per cent in the third quarter, and also added Norwegian krone and Swedish krona positions.

“Investment strategies that may have worked well over the past decade are not as likely to be effective in the next one,” Mr Hasenstab warned in a note to clients. “Investors need to prepare for today’s challenges by building portfolios that can provide true diversification against highly correlated risks present across many asset classes.”

Nordic currencies are not to everyone’s taste, as they are vulnerable to trade tensions and are much smaller and less liquid than the US dollar and Japanese yen. And both those two major currencies are vulnerable to interventions if they strengthen significantly.

That leaves an unpalatable choice for investors. Gold might have been termed the “barbarous relic” by John Maynard Keynes nearly a century ago, but its usefulness as a haven has been proven many times. The usual criticism that gold offers no actual cash flows has less bite when $13tn worth of bonds are trading with negative yields.

Gold has done little of note since its post-crisis peak in 2011, to the frustration of goldbugs wailing about central banks debasing fiat currencies. Perhaps its time to shine is nigh.

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