What do you Mean by Safe-Haven Assets?
Safe-haven assets are the financial assets that do not tend to lose substantial value and remain stable in times of market downturns or recessionary phases in the economy. These assets are of high quality and are relatively safe than other regular financial assets such as real estate, risky stocks, cryptocurrencies, etc. In times of turbulent and volatile markets, these assets either remain stable or may even appreciate in value despite an unfavorable situation. Or the value loss may be significantly very less. Investors across the world have come to discover that few assets have more or less performed well during various economic crises. Through this experience and the nature of those assets, we club them in our list of “safe-haven assets.”
However, it is not necessary that these assets will perform in a similar way amidst each and every type of market crisis. Some may perform well in a particular crisis and still lose value in another economic downturn.
Risk Exposure and Safe-Haven Assets
Safe-haven assets are a good way to limit exposure to other risky assets that may lose value significantly during instability and volatile times in the markets. It is up to an investor to identify such assets correctly. He will then have to make the important decision of what percentage of his total investment should comprise of safe-haven assets. And to what extent he will be willing to put his assets in the risky category to earn a higher return.
For a risk-averse investor, this percentage may be very high. It may even comprise the majority of his investment portfolio. The flipside to this will be the fact that such assets usually provide very little or limited returns. Hence, he will earn small returns on his investments. On the other hand, a risk-taking investor may limit the percentage of “safe haven assets” in his portfolio. He may not include them at all or may invest a small percentage of his total investable amount in such assets. He may end up earning big profits when the economy is performing well. Or may lose big too in case of an economic downturn.
What are the Main Characteristics of Safe-Haven Assets?
Safe-Haven assets are usually limited in supply. Because an excess of supply over demand of such assets will pull down their prices, this will contradict their basic purpose of providing stability in value during unfavorable market situations.
Absence of Substitutes
These assets should be such that there should not be any substitutes available for them. They should be irreplaceable, which means that they will not lose value due to the availability of similar products.
Permanent in Nature
There should be negligible chances of “safe-haven assets” getting outdated or obsolete, resulting in a loss of their value. Also, they should not rot or decay in form or shape over time.
Safe-haven assets should be liquid in nature. By this, we mean that the holder or investor should be able to convert them into cash in a short span of time. The time for their conversion into cash should not be more than 2-3 days if an emergency need arises. Moreover, apart from quick conversion, these assets should not lose value due to quick conversion.
It is not necessary that every “safe-haven asset” has all the above characteristics. An investor will have to choose very wisely between such assets according to the state of the current economy. And the asset class that fulfills his need to the maximum extent.
What are the Main Safe-Haven Assets?
Treasury Bills or T-bills are one of the safest debt securities in the world. They have the backing and security of the U.S. government. Thus, they can never default on the payment of either the coupons or the principal amount at the time of maturity. This is the reason that people flock to buy treasury bills in times of distress or turbulent economic conditions. The principal amount is safe, and it pays the due coupons on time, too, ensuring regular income for the investors. And this characteristic continues to play even during times of uncertainty in the economy.
Cash or liquid money is undoubtedly the best form of protection against uncertain and bad economic conditions. An investor will have to look nowhere nor seek anybody’s help during the worst of times if he has cash stocked up with him.
However, cash has the demerit of not being able to provide any yield or interest to its holder. Also, persistent inflation in the economy will result in bringing down the real value of stockpiles of cash as the investor will continue to see erosion in his purchasing power over the years due to inflation.
There are few currencies in the world that are considered to be a more safe and more stable form of the store of value than the rest. Some of such available strong currencies are the US Dollar, the Yen of Japan, and the Swiss Franc. In times of economic downturns, these currencies do not tend to lose much value. They have a strong and stable economic and political situation in their country. Also, they have full investor confidence in terms of ease of liquidity. Many foreign governments hold their reserves in one of the three currencies. Moreover, the future economic growth prospect of these countries is also good.
Therefore, investors can convert their respective currencies into these currencies and protect them from erosion and loss of value in times of economic turmoil.
Gold plays multiple roles across the world. For some, it is the safest store of value. Some treat it as an inflation hedge. Whatever the role is, it is undoubtedly one of the best “Safe Haven assets” in the world. Over the decades, gold has hardly fallen in value during any of the global downturns. In fact, it has shown a steady rise in value even during testing times like the global financial crisis of 2008 and the more recent Covid-19 phase.
Time and again, investors have shown their faith in this yellow metal in times of any economic turmoil. They dump their investments in more risky stocks and divert them into investments in gold. The rise in demand helps to keep its prices stable. It may even appreciate when all other investment options are crashing in value terms.
Stocks of Defensive Nature
Stocks, in general, do not constitute “Safe-haven assets.” However, there are some sectors in the economy that remain stable or even show positive growth, no matter how bad the overall economy might be performing. This is because of the very nature of those sectors where the demand never subsides considerably. Instead, demand continues to rise with rising population, rising income levels, rising mortality rates, the spread of pollution and viruses, technological advancements, etc. So the experts call stocks of these sectors of the economy as “Safe-Haven assets.”
These sectors usually comprise consumer staples, the pharmaceutical sector or the healthcare sector, and utility service providers. The global economy might be falling, but still, people will require electricity, gas, and other utility services, food to eat, and medicines and healthcare services to live. Therefore, in times of economic turmoil, investors rush to purchase the stocks of such companies. It is a belief that, unlike other stocks, they will not fall significantly or may even be in the green. These sectors of the economy are also called as “Defensive Sectors.”
Most of the “safe-haven assets” that we have looked at above have performed reasonably well time and again during various economic downturns and disturbances. When we compare the returns during unfavorable times for the investors from the usual equity market, the highly risky cryptocurrencies, and illiquid investments such as real estate, we find that the above assets have remained stable and have even provided some positive returns.
However, this does not guarantee the performance of any particular asset in any forthcoming market crisis. A crisis in the markets is unique. At the same time, some crises occur due to the bursting of the balloon of greed, blinded euphoria, and over-investments in the equity and derivative markets, like in the year 2008. On the other hand, other such scenarios may occur due to some devastating global pandemic such as the Covid-19. Hence, assets also behave uniquely and not in a similar fashion across the situations. Investors should use their judgment, experience, and foresight to choose the right mix of “safe-haven assets” so that they sail through well with the advent of any type of market downturn.