The short, sharp equity market fall in early August shocked many investors and put volatility, risk and diversification firmly back on the agenda.
Even though stock markets recovered rapidly last month, many risks remain on the horizon, from a potential US economic slowdown to geopolitical tension, leaving investors wondering how best to protect their wealth.
Below, experts explore which safe haven assets still merit a place within investors’ portfolios.
Cash
Cash is the ultimate safe haven, said Faisal Sheikh, managing director of Monmouth Capital, a wealth manager for entrepreneurs and high-net-worth individuals.
If you lose your job, “the only thing that will pay your bills is cash” and, in the real world, “safety means having enough cash to see you through a crisis”. This is the first thing he discusses with his clients before getting into investments or asset allocation.
In a severe economic crisis, any liquid assets that can be sold for cash will be, sending valuations plummeting. “Take March 2020 and the onset of the Covid-19 pandemic. There was panic: investors were selling everything they could get their hands on. If it was liquid and there was a price offered, they took it,” he recalled.
“Why? Investors were desperate for cash. They feared being in a situation where they had payments due – loans, bills or other spending needs – and didn’t have the cash to make them.”
Currently, savings accounts are still delivering a relatively high yield but that is likely to fall as interest rates are cut. Over the long term, cash does not keep pace with inflation, leading to a loss in real terms. Besides, there is an opportunity cost to keeping a large chunk of your wealth in cash – missing out on higher returns elsewhere.
Gold
Another way to think about safety (besides having enough cash to meet your needs) is shelter from market downturns, Sheikh said. “We consider safe havens as assets that move differently to equities and bonds. Gold stands out.”
And with the yellow metal hitting highs, investors who hold it have been well rewarded. Neil Wilson, chief market analyst at Finalto, said: “Gold cannot be held in check – with spot breaking through $2,600 at last on a combination of a weaker dollar, more inflation, lower real and nominal yields, plus geopolitical risk premia.”
However, Sheikh believes that focusing on the current gold price misses the point that gold provides diversification and can be a store of value during periods of equity market stress. The opposite is also the case: gold can drag on performance during equity bull markets.
“Gold has historically had low correlation to major asset classes, especially equities, yet is volatile. What this means: its price moves around a lot, but not in rhythm with the prices of equities or bonds,” he explained.
Monmouth Capital added gold to its lower and moderate risk portfolios in 2019 for its diversification benefits. “Its presence had a dampening effect on the amount that client portfolios jumped up and down – which is important if your client wants or needs a smoother investment journey,” he concluded.
Government bonds
Monmouth Capital previously had a low allocation to government bonds but has been increasing its exposure in lower risk portfolios during the past two years. For conservative investors aiming for a modest return, gilts yielding 4% “give you a lot of the returns you were hoping for” and are arguably “the best guaranteed asset”, Sheikh said.
Yet the notion that government bonds are low risk was dispelled by the 2022 fixed income rout.
Jason Borbora-Sheen, co-portfolio manager of the Ninety One Diversified Income fund, said it is par for the course for individual gilts to be volatile. “If you buy a 10-year gilt today, it’s a very normal experience to lose between 10% and 15% of capital in any one year up until the maturity and 2022 is not a one-off in that sense.”
Going forward, the speed of interest rate cuts is a key conundrum for bond investors, who are facing three potential scenarios, he continued.
The first is that central banks cut interest rates to a meaningful degree because economic growth is slowing. That would be the best outcome for the Ninety One Diversified Income fund, which could make total returns of 12-15%, Borbora-Sheen said.
“Rate cuts would be very beneficial for us, we would participate on the income side and the capital gains side, but we don’t set the portfolio up just to benefit from one outcome. If you’re trying to provide defensive characteristics, you can’t just bet the farm on one outcome,” he pointed out.
The second scenario would be a soft landing without many rate cuts. Investors in the Diversified Income fund would receive its 5.5% yield but they would not make capital gains on top. Bond markets might even be at risk of a sell-off in the near term, which is why Borbora-Sheen has reduced duration (interest rate sensitivity) during the past month from four years to just over three years.
The third outcome would be an unexpected uptick in inflation. This would be the most painful scenario although the fund’s high yield would give it “ballast”.
A related concern is whether inflation will be higher and more volatile going forward, which could cause equities and bonds to become more closely correlated and make fixed income “a threat rather than an opportunity”, he added.
Alternatives to gilts
Gilts are the Ninety One Diversified Income fund’s fourth-biggest exposure but Borbora-Sheen prefers Australia and New Zealand’s government bonds, “where you’re getting very high income of 5.5% often on a five-year bond that is issued by an AA-rated country”. New Zealand raised interest rates earlier than the UK, has seen inflation and growth fall and now has scope to reduce rates faster than the UK, he said.
Borbora-Sheen has also invested in short-maturity emerging market bonds and has hedged the currency back to sterling to create a position that behaves like a short-dated gilt. Much of the volatility in emerging market debt is caused by currency risk, although investors have to give up some of the yield to hedge it, he explained.
Sheikh prefers infrastructure funds to government bonds. The former are often backed by government contracts, have fixed return arrangements and deliver higher yields than government bonds, he explained.