This is the first in a series of three pieces that look at low risk assets.
Looking across multi-asset at what constitutes low risk assets is a good place to start because, perhaps surprisingly, the answer’s not always the same. US Treasuries are seen as the definitive safe haven asset and that perception was reinforced during the last three decades.
US government bonds have made high returns over that period, perhaps suspiciously so for a safe haven. Nevertheless, during equity market downturns, they also provided some balance in portfolios, generally benefiting from central bank easing, so they retained their safe haven crown.
No more: the dominant economic risk dynamic has changed and, with that, so has the nature of what constitutes a low risk asset. The last thirty years have been very clearly defined by low inflation and very low rates. The dominant risks were weak growth and deflation. In stark contrast, more recent times have been characterised by rising inflation and more hawkish central banks.
In this inflationary environment, US Treasuries, far from being safe haven assets, have been one of the primary expressions of inflation risk. As a result, US Treasuries and many bond sub-asset classes have experienced losses over the recent period, as a more inflationary environment is seeing nominal assets like bonds struggle.
That said, bonds are the biggest asset class in the world and, with that, comes numerous sub-asset classes with different qualities, ranging from cash-like to equity-like. In short, not all bonds are the same, a subject which we will be exploring later on in the series.
So, what constitutes a low risk asset in a world of higher inflation? In some ways, the risk hierarchy gets turned on its head. Many of the non-fixed income areas, such as equities, commodities and property are real assets, and so are more inflation-friendly. As a result, they might well end up behaving in a lower risk fashion, in a relative and absolute sense, even though they are traditionally considered higher risk. Indeed, the importance of considering how assets behave in relation to each other shouldn’t be underplayed, especially in the wider context of diversifying portfolios.
In addition to this new medium term economic dynamic, geopolitical risk has spiked recently due to Russia’s military action in Ukraine. Other than generally hurting risk-on assets, it has had two major impacts on financials assets. Firstly, safe haven assets like US government bonds and gold have benefited, secondly many commodities have surged higher due to concerns around their supply, for example energy and wheat. As a result, this has further increased the momentum for higher inflation and it has muddied the waters for central banks by increasing stagflation risk.
Certainly, in our opinion, the structure of what low risk means is changing. As a result, low risk portfolios need to change too. For global multi asset funds, especially in the perceived lower risk IA Mixed Investment 0-35% Shares sector, we believe that a pragmatic mindset and a liquid portfolio are helpful attributes at times like this because what has been low risk in the past might well not be in the future.
Next week we will look at a number of theoretical levers that can be pulled, across assets, from a low risk perspective and for the third and final week, we home in on what we are actually doing in our lower risk funds currently.