Why There’s No Such Thing As A Safe Haven
Investors who flocked to “safe haven” assets over the past several years suffered a rude shock in 2013. Government bonds, the security blanket of choice for investors traumatized by the global credit crisis, lost 2.2% in the first half of the year. Yet this disappointing performance looks absolutely scintillating compared to gold bullion.
Gold, whose reputation resides in its ability to act as portfolio insurance in difficult times, went into free-fall in 2013 losing nearly a quarter of its value. The hefty returns racked up over the previous three years just evaporated.
Unquestionably, more than one gold bug feels like they have splatted on a windshield.
What about hedge funds that are supposed to “hedge out” market risk? The most zealous advocates of hedge funds market them on their ability to deliver “absolute” positive returns, regardless of the volatility of direction of the market. In point of fact, the only absolute is that this absolutely did not occur. Canadian hedge funds, as measured by the Scotiabank Canadian Hedge Fund Index, lost 2% for the first six months of this year. In fact, since they peaked in the spring of 2011, hedge funds have sunk deeply into the red suffering a 14.1% decline.
The reality is that there is no such thing as an unconditionally safe haven asset. Government bonds are exposed to interest rate risk – when interest rates rise, bond prices drop. Mesmerized by the healthy returns government bonds delivered during the dark days of 2008, many investors failed to heed this fundamental. Bond losses can be daunting. In 1994, when interest rates surged, government bonds in Canada lost over 11% in five months.
Bonds become extraordinarily risky in periods where inflation continuously exceeds expectations. Chronically rising interest rates repeatedly send bond prices tumbling while ever higher inflation undercuts the purchasing power of the interest payments. Long-term Canadian bonds lost a mind-boggling 48% in real terms over the period from 1973 through 1981 when inflation spun out of control.
Gold does act as a form of portfolio insurance, frequently doing well when the stock market drops precipitously. But much like the drain of home insurance protection that never delivers a nickel, gold can under perform for prolonged periods when markets are doing well, especially when inflation is not a threat. During th bull markets of the 1980’s and 1990’s, gold lost nearly 62% of its value over a tortuous nearly 19-year period. And since, unlike stocks and bonds, gold doesn’t pay a dividend or coupon, there is no income to cushion price declines.
When it comes to hedge funds, the promise of “absolute returns” says more about canny marketing than it does about their characteristics as a group. In 2008, Canadian hedge funds plummeted nearly 27% as the full fury of the crisis sent stock and credit markets into a tailspin. Only a handful of hedge funds or strategies such as managed futures actually weathered the storm well.
Other candidates for safe haven status have their drawbacks as well. The remarkable stability of GIC’s is a reporting illusion. They are carried at book value on account statements. If GIC’s were marked to market like bonds, they would experience similar volatility to short-term bonds. High quality short-term investments like T-bills do provide stability of normal capital, but expose investors to reinvestment risk as interest rates fall and frequently are losers net of inflation. Since 1926, U.S. Treasury Bills have lost money on an inflation-adjusted basis nearly 40% of the time.
The pursuit of “safe haven” assets obscures what investors should be doing to manage portfolio risk. A personalized strategy based on sound diversification that reflects a broad mix of assets is as close to a haven as any investor is going to get.