Faced with terrorist attacks in Paris and the possibility of an interest rate liftoff at the Federal Reserve, investors have avoided rushing into traditional ‘safe haven’ assets such as gold.Alessia Pierdomenico/Bloomberg
Faced with terrorist attacks in Paris and the possibility of an interest rate liftoff at the Federal Reserve, investors did something unexpected. They avoided rushing into traditional "safe haven" assets such as U.S. Treasuries, gold, and the Swiss franc.
The lack of a notable flight by investors to the usual defensive portfolio positions suggests that the perception of haven status has changed. As markets move toward Fed liftoff, possibly as soon as next month, a debate is picking up, not only about performance expectations for haven assets in an environment with potentially rising yields, but about which assets are likely to draw haven flows.
The global financial crisis, the subsequent sovereign debt crisis and the resultant expansion of central bank balance sheets have shaken investors' perceptions as to what assets warrant haven status. Assets previously regarded as secure have proved to be anything but.
On the other hand, riskier assets such as corporate debt or volatile emerging-markets currencies have at times benefited from haven flows. Meanwhile, traditional haven currencies, including the Swiss franc and the Japanese yen, have fallen out of favour, undermined by activist central banks. Russia's ruble gained as much as 1.9 per cent on Monday in the wake of the Paris bombings, for instance, as crude oil prices rallied. The Swiss franc and the yen fell against the U.S. dollar.
In fixed income, sovereign debt, while still a magnet for haven flows, is no longer seen as an entirely risk-free asset following expansive policy action from the world's central banks. As risk has shifted from private sector to public sector balance sheets, the spectre of sovereign debt defaults in developed markets has grown.
Corporate bonds, with alluringly low default rates and the prospect of incremental returns in this low-interest-rate environment, have in some instances become the risk-free asset of choice for fixed-income portfolio managers. The level of investor comfort with this asset class is evident in its robust price performance and spread compression in the wake of the sovereign debt crisis. The backstop bid from central bank accommodation has encouraged investors to move down the quality curve in search of yield. As a result, credit-quality curves have flattened as investors chase outsized returns into sub-investment grade levels, and emerging-market credit risk is also viewed as an attractive source of yield.
Corporate credit may still be more appealing than higher-leveraged sovereign balance sheets, but recent troubles at the likes of Volkswagen and Glencore show that one size does not necessarily fit all. Standard & Poor's has already noted a pick-up in corporate default rates.
Across the corporate credit spectrum in developed and emerging markets, investors increasingly recognize the need to focus on fundamentals and seem aware of the embedded idiosyncratic risks in corporate credit.
Pension funds have historically favoured hard assets, including such asset classes as infrastructure financing and/or big commercial real estate deals. Both may still hold haven status for some investors.
In emerging markets foreign exchange, the Indian rupee's relative strength may continue, given the currency's hard-to-beat, long-term fundamentals. Both the Chinese yuan and the Russian ruble may benefit over time from last weekend's news; the probable inclusion of the yuan in the International Monetary Fund's basket of reserve currencies could boost the yuan's appeal, while the atrocities in Paris may reduce geopolitical pressure on Russia. Any short-term boost might be limited, however. Central banks are likely to be slow to change their reserve currency allocations, and low oil prices may continue to weigh on Russia's balance of payments.
Overall, investors may prefer sticking to emerging markets that have solid fundamentals rather than indulge in panic selling, especially as the pool of available developed-market haven assets continues to shrink.
A case in point would be peso-denominated Mexican government bonds, known as Mbonos. Bloomberg data show that foreign ownership of Mbonos has advanced slowly, yet steadily, since the end of 2012, even as ongoing concerns over financial stability in Mexico and expectations of Fed interest rate increases in the near future dropped the Mexican stock market around 24 per cent versus the U.S. dollar.
Fallout from financial and sovereign debt crises and the ensuing growth of central bank balance sheets appear to have spurred a marked shift in perception as to what assets warrant haven status. There may no longer be a single definition (or set of criteria) representing haven status. Certainly there is no single asset everyone would consider likely to offer refuge from a geopolitical or market storm.