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The illusion of safety

by gbaf

By Iain Ramsey, CIO, AHR Private Wealth 

Investors’ demand for safe assets shouldn’t be a surprise after a year in which few certainties seem to remain: what might be more surprising is how difficult it may be to find them

Despite strong growth forecasts for 2021 and an end to the pandemic in sight, it would be hard to argue there’s not a strong case for caution when it comes to investment strategy. Market volatility remains a real risk and the Bank of England is less optimistic in the medium term, recently revising down growth for 2022. That is because fears of a new wave of the virus linked to new variants also persists.

It is not altogether difficult to see the appeal of low-risk investments in the current climate. It’s not clear, though, that traditional solutions meet the mark in providing the security and reliable returns required. In particular, UK gilts, traditionally the safest of safe havens for British investors, have failed to live up to their billing in the first quarter. Long-dated Government bonds, in particular, have proved more volatile than many equities over the period – primarily as a result of growing fears about inflation.

Britain needs to avoid an inflation spike “like the plague”, the Bank of England’s chief economist told the Treasury Select Committee in May. So far, the markets seem to have concluded that the jury’s out on whether it can do so.

Iain Ramsey

Iain Ramsey

Investment asset options
While uncertainty persists, investors must re-evaluate what constitutes a safe asset in a post-pandemic economy. If the risk of inflation remains, gilts and corporate bonds are likely to see further falls in prices – and with little compensation in terms of yields.

In looking at their options, there are other areas they could turn to, but a few stand out. The first is, broadly, alternatives, and specifically those that have a track record in inflationary environments. That includes gold, but also other commodities like copper or timber. They don’t provide a yield, but they have historically provided good protection in inflationary environments, rising with prices. In recent years they’ve also become much more accessible for investors with a range of liquid, exchange-traded products providing exposure available. Global shortages of resources like these also tends to suggest that prices will be driven upwards.

Another option worth a look is property, which can provide both good yields and opportunities for price growth. A mix of residential and commercial could offer a strong solution in an inflationary environment; investments in warehouse distribution centres have already proved relatively resilient throughout the tumult of the last year. Again, investors can easily access this through liquid vehicles. In this case, real estate investment trusts (Reits) probably provide the most attractive option.

Finally, if investors are still looking for long-term growth and more traditional fixed income returns, high-yield should be considered. Its increased returns and lower sensitivity to inflation than investment-grade corporate bonds or Gilts could make it attractive.

Investment principles to remember
High yield does, though, pose more risk for its reward. If recovery falters, that could mean rising defaults. That’s why, while considering the asset mix, investors should also keep a couple of key principles in mind.

The first is the benefits of diversification. Investors need to look at a range of options and avoid concentrating portfolios in highly correlated assets. Alternatives can be particularly powerful in providing that diversification, offering a degree of protection – whether inflation takes off or not.

The second is the value of active management, which has been somewhat overlooked in recent years. Just as investors have grown used to ignoring inflation, they’ve also enjoyed a long period of good returns from simple, passive products. Both are luxuries they arguably can no longer afford.

Of course, there’s still a strong case for long term investors to benefit from the efficient market exposure than an allocation to passive investments provides. But the increased volatility we’ve seen in bonds argues for greater use of active management in two respects: First, investors in passive vehicles may not always have great clarity of the underlying exposures; simply investing in a global aggregate bond ETF, for instance, may leave them unwittingly exposed to some very long-duration government bonds.

Second, active management allows for a more tactical approach to cope with the volatility and uncertainty we’ve seen and continue to experience. It can mitigate the risks of investing in high yield, for instance, if a manager can be selective, weight the portfolio towards better quality bonds and respond quickly to any signs of increasing defaults.

Ultimately, safe assets have traditionally provided not just security but also a reliable source of long-term growth. If investors want both in future, they may find they need a more imaginative and proactive approach.

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