How do safe haven assets perform in a crisis?

I’m more interested in safe-haven investments than I used to be. And it’s not just that I’m into my sixties now, although clearly that is a part of it. More than just the ticking clock, it’s that the last five years have made the world feel a great deal more uncertain.

Two wars, the growing risk of recession after nearly three years of rising interest rates, and an unpredictable US election are the obvious factors. But the increasingly clear impact of climate change and the nagging fear that the next pandemic is waiting in the wings are concerns too. All that while equity markets sit at historically high valuations.

On the basis that it is better to fix the roof while the sun is still shining, now feels like a good time to consider how to introduce some pre-emptive stability into a portfolio. The V-shaped correction and rebound recently was a free wake-up call. So, what are the best safe haven assets? How might they perform in a crisis? And how much is it prudent to hold in this kind of portfolio ballast?

Developed market government bonds are the classic go-to for safety-first investors. The risk of the US or UK government defaulting on their debts is virtually nil because they print their own currencies. Bonds typically deliver a smoother return than equities. Ahead of an expected reduction in interest rates, they offer the prospect of both a reliable income and some capital gain too. Bonds are not risk-free, and that’s doubly the case with corporate bonds which add an element of default risk to the interest rate calculation. The biggest risk with bonds is the hidden one that they fail to keep pace with inflation. On balance, though, the case for some fixed income in a portfolio is strong today.

The second traditional port in a storm, gold, has already caught the attention of investors. At US$2,500 an ounce, gold has been one of the best-performing asset classes this year. Over the past two years, the precious metal has risen by more than 50 per cent. The real attraction of gold is its lack of correlation with shares, something that bonds used to offer but increasingly don’t. In 2020, when the pandemic struck, gold ended the year 25 per cent higher than it started. In 2022, when shares laboured under the weight of rising interest rates, the S&P 500 fell by nearly 20 per cent but gold was flat. Gold is liquid - easy to buy and sell as bullion or via an ETF. Its disadvantages include its lack of income, its volatility and its sensitivity to the dollar, in which it is priced. It is also clearly less compelling after its recent strong run. But, like bonds, it has a role to play in any balanced portfolio.

A less drastic way to prepare for more challenging times is to shift the balance of the equity portion of your portfolio towards more defensive shares. The traditional safe haven sectors include utilities, consumer staples, food retailers and pharmaceuticals. You are looking to invest in companies that provide the goods and services that people buy through thick and thin, regardless of market conditions or the state of the economy. During the heavy market falls of 2022, staples, utilities, and healthcare all outperformed the wider market. And gaining an exposure to these kinds of shares is simple through a sector ETF, even if you don’t want to go to the trouble of putting together a diversified portfolio of individual shares. The final advantage of investing in these kinds of companies is that they often pay a sizeable dividend. In a falling interest rate environment, these will look even more attractive.

The fourth main safe haven asset is cash. There is actually a case for holding some cash in all market conditions, as a source of dry powder in case of a market correction and, if you are drawing down an income, as a way of avoiding being a forced seller of assets and locking in a loss. The attraction of cash today is that it still offers an attractive yield. Money market funds increase capital risk very marginally compared to a deposit account, but will help to prolong the yield premium once rates start to come down. The main disadvantage of cash, historically, has been its failure to keep pace with rising prices. In the long run this problem is likely to re-emerge. But for now it’s not really an issue.

I would hold all four of these safe haven assets today, and marginally more of them than usual. The key is to be doing this thinking now while the sky is blue. Battening down the hatches is much harder when the storm is howling and we’re much less likely to make measured decisions. Like good boy scouts it’s better to be prepared.

A second important consideration is diversification. Not all of these safe havens will work in any given set of circumstances. Knowing which will do so in advance is impossible, so covering the whole waterfront of defensive assets in roughly equal proportions makes sense.

Finally, and this is the benefit of thinking about it while things remain calm, don’t overdo the caution. This is particularly important if, like me, your risk appetite is dwindling with age. If you are anticipating being in the markets for years, or with luck, decades to come then you absolutely don’t want to eliminate investment risk. The past was also littered with wars, disease, recessions and unpredictable elections - and investors have been well rewarded for not hiding away from them.

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Please note that the views expressed in this article are my own.