Building resilient portfolios
04-11-2019
Thushka Maharaj
Sorca Kelly-Scholte
Nicolas Aguirre
Rethinking safe haven assets
Key points
- Now that a large proportion of developed market sovereign bonds have negative yields, investors essentially have to pay for the portfolio protection these bonds can offer.
- This presents a challenge in designing well-balanced portfolios—one that calls for a broader definition of safe haven assets and for devoting as much attention to efficiently building portfolio ballast as to optimizing returns.
- Investors may have more choices for building protection and resiliency into their portfolios than they think. The solutions may be surprising and the most appropriate trade-offs will vary across investors.
Portfolio protection is a clear concern for investors in the current late cycle environment, with equity markets near all-time highs, bond yields at cyclical lows and geopolitical risks increasing. What can investors do to build more resilient portfolios?
Traditionally, a critical part of the answer has been to maintain a balanced portfolio with a sufficient high quality bond allocation to mitigate equity market risk and provide reliable coupon income. That changed with the implementation of unprecedented monetary policies following the global financial crisis. A substantial proportion of developed market government bonds now have negative yields—causing some to wonder whether the concept of a “risk-free return” has been exhausted.
Today, investors effectively have to pay for the insurance bonds can provide. This presents a challenge in designing well-balanced portfolios and calls for investors to spend as much time optimizing the risk parameters of their portfolios as they do fortifying portfolio returns.
Our research indicates that traditional safe haven assets (high quality sovereign bonds, as well as FX reserve currencies and gold) still have an important role to play, while a subset of alternative assets (including private core real estate and infrastructure) may also provide attractive safe haven properties, depending on opportunity costs and investor objectives.
In our view, building more resilient portfolios requires broadening the definition of “safe haven” assets and considering the stabilizing characteristics and opportunity costs of each, balanced against the relative importance to the investor of the following survival skills:
- Staying solvent
- Keeping cash flows stable to meet required outflows
- Capitalizing opportunistically on dislocations
A broader definition of safe haven assets
Assets that fit into our broader definition of safe havens include the following:
Bonds can still be strong diversifiers (given our long-term outlook for modest growth, low inflation and still low rates) but many no longer offer protection and a coupon.
The U.S. dollar is a highly liquid, high quality investment typically exhibiting negative correlation to risk assets in times of stress. But, it may not be a winning safe asset going forward: demand for the USD from global FX reserve managers is falling; the U.S. Federal Reserve has room to cut rates, given currently wide spreads vs. other major markets; USD valuations are high; and foreign exchange policy is showing signs of moving toward active currency depreciation.
Gold has provided stability under a range of economic and market environments. Its desirability as a safe haven may increase as low yields raise the opportunity cost of bonds and if interventionism should take hold, weakening the USD as a store of value.
Core private real estate can offer stable, high quality income streams, providing a strong offset to its lack of liquidity. Additionally, it can provide a relatively low, though positive, correlation to equities and lower accounting vs. economic volatility.
Infrastructure has safe haven characteristics similar to those of real estate and a promising outlook given the demand for green projects.
Investors may have more choices for constructing resilient portfolios than they think. However, effectively embedding safe haven assets is likely to require as much attention to building portfolio ballast as to optimizing returns. The solutions may be surprising and the most appropriate trade-offs will vary across investors.
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