Every economic downturn invariably leads to a flight-to-safety among investors, but the COVID-19 outbreak has been among the most rapid.
Historically, several safe-haven asset classes have been strong performers and could become a permanent part of some portfolios as investors reassess the risk of future pandemics.
Let’s take a look at common safe-haven asset classes and how you can build them into your portfolio.
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What Are Safe-Haven Assets?
Safe-haven assets, as their name suggests, are assets that are considered “safe” during periods of economic uncertainty. In other words, they tend to either retain or gain value during troubled times. Analysts quantify an asset’s safety by looking at its correlation with conventional assets along with other criteria, as shown below, that make them desirable to own during a downturn.
| Characteristic | Implications |
|---|---|
| Correlation | They should have little or negative correlation with the economy or conventional assets |
| Liquidity | They should be easily convertible into cash at any time – even when there’s a credit crunch |
| Supply & Demand | They should have a limited supply and/or stable demand to maintain price stability |
| Permanence | They should not inherently decrease in value over time or incur a high maintenance cost over time |
Investors turn to safe-haven assets in order to remain solvent, stabilize cash flow, and generate income to capitalize on opportunities from market dislocations.
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A Review of Safe-Haven Asset Classes
There are different types of safe-haven assets. While bonds and gold are the most well-known from a historical perspective, inflation-protected securities and cryptocurrencies have also been lumped into the category. It’s important to carefully assess the pros and cons of each option before committing any capital to them.
There are different types of safe-haven assets. While bonds and gold are the most well-known from a historical perspective, inflation-protected securities and cryptocurrencies have also been lumped into the category. It’s important to carefully assess the pros and cons of each option before committing any capital to them.
| Safe Haven Asset | Pros | Cons |
|---|---|---|
| Cash or Money Market Funds | LIQUIDITY - Cash is synonymous with liquidity and can help meet any immediate financial obligations | NEGATIVE YIELD - Cash doesn't offer any yield – in fact, it may depreciate in value due to inflation |
| Government Debt | LIQUIDITY - Government bonds are easily converted into cash | LOW YIELD - Government bonds do not offer as much yield as other fixed-income investments and some even have negative yields |
| CORRELATION - Government bonds are typically inversely correlated with equities (except if there’s inflation) | ||
| STABILITY - Government bonds provide a stable source of income | ||
| Inflation-Linked Bonds | STABILITY - Inflation-linked bonds provide a stable source of income | LOW YIELD - Inflation-linked bonds do not offer as much yield as other fixed-income investments |
| VALUE - Inflation-linked bonds provide a stable source of real value since payments are adjusted for inflation | CORRELATION - Inflation-linked bonds are more correlated to equities than conventional government bonds | |
| Defensive Equities | STABILITY - Defensive equities provide a stable source of income since consumers require their products and services in any environment. | VOLATILITY - Defensive equities may still experience volatility stemming from the overall market |
| VALUE - Defensive equities are a good store of value since they are typically blue-chip companies | ||
| Gold | LIQUIDITY - Compared to other precious metals or alternative asset classes, gold is relatively liquid and easily convertible into cash | CORRELATION - Gold’s correlation with equities is on and off |
| NO YIELD - Gold doesn’t provide investors with a yield – in fact, it often involves a storage cost | ||
| Real Estate | STABILITY - Real estate provides a stable source of income since renters are on long-term contracts | LIQUIDITY - Physical property is an illiquid asset, which means it’s difficult to sell for cash during a crisis |
| VALUE - Real estate tends to be a good store of value if it’s held over the long term | CORRELATION - Real estate does not have an inverse correlation with equities and may experience similar price swings during a downturn |
Implications for Investors
Safe-haven asset classes have different uses depending on the nature of the economic downturn. For example, some asset classes are ideal during inflationary periods, while others are ideal during deflationary recessions. Investors should understand these differences in order to choose the right option for their portfolio.
| Nature of Concern | Typical Safe-Haven Asset Class |
|---|---|
| Recession | Cash or money-market funds |
| Real estate and defensive stocks are ideal for shallow recessions | |
| Gold is ideal for an extreme recession or market downturn | |
| High Inflation | Inflation-linked bonds, such as Treasury Inflation Protected Securities (TIPS) are ideal |
| Gold is ideal when there’s a significant inflation shock | |
| Growth Shock | Government bonds are ideal |
| Defensive stocks and real estate can provide predictable cash flow |
When weighing their options, investors should carefully consider the cost opportunity and tradeoffs associated with each safe-haven asset class. Gold may seem like a very safe asset, but it doesn’t offer any yield and performs poorly outside of dire circumstances; whereas, real estate is illiquid and susceptible to a housing crisis.
The easiest way to build exposure to safe-haven asset classes into a retail investor portfolio is by using exchange-traded funds (ETFs); although, some investors prefer to invest directly in bonds or hold physical assets (e.g. real estate or gold).
Be sure to read this article to know more about tactical asset allocation strategies.
The Bottom Line
Safe-haven asset classes are common destinations during an economic downturn, but they aren’t all created equal. Investors should be familiar with the pros, cons and use cases for each safe-haven asset in order to make the right decision for their portfolio given the circumstances.
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