This site uses cookies

To give you the best possible experience, the GAM website uses cookies. You can read full information of our cookie use here.


OK

Redefining Safe Havens

As riskier assets defy doomsday expectations amid global economic uncertainty, GAM's Doug Branson warns investors not to be blindsided against opportunity in the search for a safe place to hide. The article was first featured in International Adviser's report "A guide to outsourcing investment"

4 May 2017

In 'The Devil's Financial Dictionary' safe is defined as 'an adjective used to describe any investment that is about to explode'.

Clearly, this is a tongue-in-cheek definition but it has also proved prophetic in the past. As human beings, we are psychologically conditioned to believe that the price of anything that has been rising for years will not explode.

That’s why there was no shortage of people buying UK residential property at the height of the booms in 1988 and again in 2007.

We all understand the logic of buying low and selling high but actually following this most simple of mantras in terms of investing is a different matter altogether.

A few weeks ago, the FTSE 100 Index eclipsed the 7400 level for the first time, while, on the other side of the Atlantic, the Dow Jones Industrial Average, S&P 500, Russell 2000 and NASDAQ all thundered to new all-time highs on the same day. Is the fact that major stock market indices in the developed world have, a few risk-off episodes apart, been striding relentlessly upwards for almost exactly nine years a reason for celebration or a cause for concern?

Skewed logic

It seems almost strange to think that, in the middle of last year, everybody was talking about safe havens. Not only had the media agencies universally called the result of the Brexit referendum completely wrong, the economic fraternity had warned the electorate of fire and brimstone should they dare vote to leave the EU. Of course, it was a similar case with the US presidential election.

Consequently, in the aftermath of the Brexit referendum, the BBC was swift to publish an article about safe haven investments, exhorting readers to invest in government bonds, gold and other currencies.

Chart 1. UK gilts
Performance over the long term (from 31 Dec 1982 to 27 Feb 2017) %

UK gilts

Source: Thomson Reuters, MSCI. Past performance is not indicative of future performance

Furthermore, as illustrated above, even the returns generated during a 30-year bull market for Gilts are dwarfed by those on equities. Consequently, the case for reallocating large chunks of an investment portfolio to government bonds is purely tactical and would require considerable timing skills on the part of the investor.

Chart 2. Gold
Performance over the long term (from 4 Jan 1983 to 27 Feb 2017) %

Gold

Source: Thomson Reuters, MSCI. Past performance is not indicative of future performance
Strange times

Warren Buffett famously said: ‘Gold gets dug out of the ground in Africa, or someplace. Then we melt it down, dig another hole, bury it again and pay people to stand around guarding it.’

In many respects, gold is a strange investment medium. Despite it being a commodity, it is hard to define the intrinsic value of gold as it has little utility value (as implied in the quote above). Moreover, like many other commodities, its price tends to move in secular cycles, as illustrated above. Indeed, gold endured a multi-year bear market before rallying strongly since the global financial crisis. However, the chart clearly illustrates that the long-term returns on gold have been decidedly anaemic. In addition, there are obvious concerns that the size of the ‘paper’ market is approximately 100 times bigger than the global reserves of the precious metal. Consequently, a contract conferring the holder the right to buy gold at a given price can actually only be redeemed for ‘cash for difference’ in the currency in which the contract is denominated.

Chart 3. US Dollar
Performance over the long term (from 31 Dec 1982 to 27 Feb 2017) %

US Dollar

Source: Thomson Reuters, MSCI. Past performance is not indicative of future performance


While it is difficult to define the intrinsic value of gold, the actual worth of currencies is entirely based on trust. The wording on banknotes reveals that they are in fact promissory certificates, but nobody knows the exact nature of the obligation. What does ‘I promise to pay the bearer on demand the sum of ten pounds’ actually mean? Currencies tend to trade within predefined ranges and mean revert once hitting the outer boundaries of that range. Many will be aware that the US dollar (which we are using as an example of a UK investor investing in a foreign currency as a safe haven) has been exceptionally strong in recent years but, as the above chart amply illustrates, it is difficult to generate meaningful long-term returns through buying and holding a currency. Consequently, the case is simply a tactical and opportunistic one that is again largely dependent on the ability to time the market.

Chart 4. What's happened since Brexit?
Performance over the long term (from 31 Dec 1982 to 27 Feb 2017) %

What's happened since Brexit?

Source: Thomson Reuters, MSCI. Past performance is not indicative of future performance


An equally weighted portfolio of the three assets mentioned by the BBC would have achieved a marginally positive return over this period, which is consistent with the concept of safe havens. However, the telling factor is that the Brexit-precipitated market meltdown was short lived and, therefore, the opportunity cost of not being invested in UK equities throughout would have been very significant. Again, it was a similar case with US equities following the presidential election: futures contracts on the Dow Jones Industrial Average were trading at a level consistent with an 8% fall at the opening bell in the immediate aftermath of Trump’s victory, yet equities subsequently rallied very strongly. Nevertheless, it is important to bear in mind that investors can find it difficult to tolerate the volatility associated with higher-returning risk assets.

Chart 5. Understand asset class volatility
Volatility %

Understand asset class volatility

Source: GAM/ Bloomberg: data from 31 Dec 2003 to 28 feb 2017 unless otherwise stated. Indicies represented by MSCI Emerging Market Index (GBP), FTSE All-Share index (GBP), GAM MPS Balanced Portfolio (GBP), Barclays Global Agg Total Return Index Hedged (GBP), IA UK Gilts Average (GBP), HFRI/HFRX Global Hedge Fund Index (GAM hedged) (GBP) and Average GBP 1 Month Deposit Rate (as at 28 Feb 2017). Past performance is not indicative of future performance. Funds do not have the security of capital which is characteristic of a bank deposit. Please note this analysis contains simulated data and does not represent actual performance or risk characteristics achieved by investors.

Unsurprisingly, of the asset classes illustrated above, emerging market (EM) equity is the one that has fluctuated the most, while cash (as measured by the one-month deposit rate) is the least volatile. Meanwhile, the royal blue squares (balanced portfolio) typically occupy the middle ground in terms of volatility, proving less volatile than UK equities in 12 out of the 13 calendar years analysed. But what about performance…

Chart 6. Meaningful diversification
Simple performance returns %

Meaningful diversification

Source: GAM/ Bloomberg: data from 31 Dec 2003 to 28 feb 2017 unless otherwise stated. Indicies represented by MSCI Emerging Market Index (GBP), FTSE All-Share index (GBP), GAM MPS Balanced Portfolio (GBP), Barclays Global Agg Total Return Index Hedged (GBP), IA UK Gilts Average (GBP), HFRI/HFRX Global Hedge Fund Index (GAM hedged) (GBP) and Average GBP 1 Month Deposit Rate (as at 28 Feb 2017). Past performance is not indicative of future performance. Funds do not have the security of capital which is characteristic of a bank deposit. Please note this analysis contains simulated data and does not represent actual performance or risk characteristics achieved by investors.


Over the last few years, EM equities have proved the best-performing of these asset classes, while cash features in the bottom half of the table in 8 out of 13 of the complete calendar years analysed. Interestingly, the balanced portfolio (royal blue) features in the middle-to-top half of the table in each of the periods illustrated above, including 2008 (when Gilts proved a safe haven in a year of mayhem), 2009 (the year of the v-shaped equity recovery) and 2011 (when the eurozone crisis cast a shadow over risk assets).

Guaranteed mediocrity?

The attraction of safe haven investing is that it should provide guaranteed mediocrity in times of uncertainty. But this comes at a significant opportunity cost when riskier assets defy doomsday expectations – as has been the case post Brexit and the US presidential election. In addition, many so-called safe haven assets move in secular cycles or fluctuate within historic price ranges. Consequently, market-timing skills are required to tactically and opportunistically take advantage of them.

The alternative is to seek to reduce portfolio volatility through diversification, effectively making the issue of safe havens redundant in a medium-to-long term context. The most practical way to achieve this objective for many investors is to invest in a balanced, multi-asset portfolio, which seeks to blend complementary return streams to reduce the impact of volatility, while offering the potential to deliver attractive returns over the course of an economic cycle.


Important legal information
The information in this document is given for information purposes only and does not qualify as investment advice. Opinions and assessments contained in this document may change and reflect the point of view of the author in the current economic environment. No liability shall be accepted for the accuracy and completeness of the information. Past performance is no indicator for the current or future development.