Investors relying on just one safe-haven asset need to rethink their approach to asset allocation as the ultra-low rate environment has made holding some traditional portfolio protectors detrimental to their wealth, according to the JP Morgan Asset Management multi-asset team. 
Holding safe-haven assets has always involved a trade-off, the team noted, but has paid off over the past 30 years as positive yielding bonds have compensated investors, providing both income and capital appreciation.
But the onset of the Covid-19 pandemic – after a decade of post-crisis, ultra-loose monetary policy – has seen central banks cut interest rates to near-zero levels to stimulate economies.
As such, a large proportion of developed market sovereign bonds are now yielding zero or less, the multi-asset strategists noted, “making the opportunity costs of holding bonds painfully apparent”.
And this means that investors need to challenge the concept of “risk-free return” as they are paying for the portfolio protection that bonds provide.
Yet, with equity markets near all-time highs, bond yields at cyclical lows, and geopolitical risks increasing, the need for diversification has never been greater.
Therefore, investors should consider which safe-haven assets that they hold in their portfolios.
“In the traditional sense, an asset is considered ‘safe’ if: it serves as a store of value – i.e. generally maintains or even increases in value through market cycles; can be readily converted to cash without significant loss of value; and exhibits low volatility,” the JP Morgan team said.
“Importantly, safe-haven assets have a low or negative correlation to the general market and can protect portfolios during times of stress.”
When considering what is a ‘safe haven’, investors are seeking to add assets that in a downturn or period of market volatility allow them: stay solvent, keep cash flows stable to meet outflows and ensure a little ‘dry powder’ to capitalise on opportunities arising from market dislocations.
High-quality sovereign bonds have come to be seen as 'ballast' for a balanced portfolio equity due to their negative correlation with equity markets and are likely to continue to play a role in portfolios for some time.
“In our view, high-quality bonds will remain viable safe-haven assets during the next 10 to 15 years, given our expectation for muted inflation,” the team said. “Bonds are likely to provide a return of capital – even if they don’t provide return on capital. They also offer protection in a market downturn and the liquidity required to take advantage of dislocations.”
But while high-quality bonds may still be the most appropriate for some investors there will be others for whom the opportunity cost is too high.
Reserve currencies such as the US dollar are also under greater scrutiny despite their highly liquid nature, according to JP Morgan’s multi-asset managers.
Indeed, the US dollar might not be a clear winner in the next downturn as demand has fallen and its value has increased.
“The trade-off when assessing the dollar as a safe-haven asset is between the negative implications of holding an asset that is clearly overvalued and subject to the apparent willingness of the Federal Reserve to provide ample dollar liquidity as a first resort in any crisis vs the ability to take advantage of market dislocations that ready dollar cash provides – which may be attractive to investors with a more dynamic stance to trading their portfolios,” they noted.
Therefore a basket of “classic safe-haven currencies” might do better in times of stress.
“As a result, diversifying the currency hedge to include the Japanese yen and Swiss franc should provide protection across a wider range of downturn scenarios,” the strategists added.
On gold, the multi-asset team highlighted its negative correlation to equity markets but it has seen “lacklustre” returns during periods where inflation falls in a period between extremely low levels (below 1 per cent) or high (above 3 per cent). Periods such as now.
“In the coming years, gold may gain appeal as a diversifier if monetary policy becomes less potent and low to negative rates reduce the opportunity cost of holding gold,” the team said. “Moreover, in a politicised environment in which authorities may favour currency debasement, gold as an alternative diversifying safe-haven asset is gaining traction among investors.”
As such, core real estate and infrastructure investments may be more suitable safe havens for investors in the current environment with their stable and high-quality income streams offsetting their lack of liquidity.
“While real estate – and other alternative assets – exhibit significant economic volatility (actual realised volatility), their accounting volatility can be lower, mostly due to their quarterly reporting frequency,” JP Morgan’s multi-asset team said. “The lag in appraisals does help to smooth returns.
“However, for real estate these lags have been reduced since the 1990s, and an increasing number of open-end diversified core equity funds have introduced more third-party oversight procedures to ensure valuations are credible and timely.”
Ultimately, it comes down to the investor to decide which asset best meets their investment needs and how it fits with the rest of their portfolio. Investors should spend as much time on monitoring the risk in their portfolios as they do on return generation.
“There is simply no single, perfect safe-haven asset,” the strategists concluded. “Markets and economies are dynamic and present multiple and changing risks. Investors have different risk exposures and protection priorities.”