For information purposes only. The views and opinions expressed here are those of the author at the time of writing and can change; they may not represent the views of Premier Miton and should not be taken as statements of fact, nor should they be relied upon for making investment decisions.
We recently wrote on how being open-minded about diversifying geopolitical risk in portfolios is generally rewarded by markets.
As the chart shows, from the beginning of the recent Israel/Palestinian conflict to now (i.e. 9th October 2023 to 20th October 2023), which is admittedly a short period, US Treasuries have fallen in line with equities, the trade weighted (TWI) US dollar is about flat, while oil has benefited materially but gold is the stand out performer.
Source: Bloomberg data from 09.10.2023 to 20.10.2023.
Past performance is not a reliable indicator of future returns
There is a lot more to the story than the initial observation that gold behaved like a safe haven and US Treasuries didn’t.
US Treasuries are conflicted: they are buoyed by their safe haven role but undermined by the hawkish environment for rates. This is not just reflected in losses for US Treasuries but also in their current elevated volatility. Neither losses, nor elevated volatility, are consistent with how investors expect a safe haven to behave in a risk-off episode.
It is clear that the market continues to believe that the primary risk is inflation, which is only compounded by a higher oil price due to the nature and location of the conflict. That’s not to say that this is how this traditionally safe haven will behave going forward. Nevertheless, higher for longer is a powerful trend and is impacting right across asset class, not just safe havens.
Our longer term clients will remember our lower for longer view, which we held for many years. This was an extended period when all assets were driven by the primary dynamic of lower for longer rates. This went on for decades and was repeatedly questioned, and rightly so, for the first few years before investors got on board and then, in general, got out of the habit of questioning that dominant force. We are now in exactly the same environment, only in reverse, with investors consistently assuming a reversion to lower for longer. Clearly, higher for longer won’t go on ad infinitum but trends generally carry on for longer than investors expect.
Pragmatism dominates everything we do. The pitfalls of not having a pragmatic approach to risk is well illustrated by some of the multi asset passive funds. This is particularly well illustrated in the IA Mixed Investment 0-35% shares sector, where there tends to be a material bias to bonds. Many of these funds did very well in the lower for longer period, in absolute and relative terms, in large part as their bond exposures had a bias to long duration. As a consequence of this strong performance, and low charges, their fund sizes grew significantly, and they now make up some of the largest funds in the sector. However, in the last three years, more recently dominated by a higher for longer environment, a number of these funds have had a shocking period of performance, due to the same exposure to long duration. In short, the environment changed, and these funds’ asset allocation didn’t. Indexing has risks, both absolute and relative, especially those multi asset funds that don’t actively manage their asset allocation.
