Why traditional safe havens might not work

In the market sell-off this February, defensive assets failed to defend.
The Green Line
Duncan MacInnes
Investment Director

‘The only free lunch in investing’. That is how Harry Markowitz, Nobel Prize winner and creator of modern portfolio theory, described diversification back in 1952.

If diversification is to be effective, a portfolio will include assets that thrive in challenging times. The role of these ‘anti-fragile’ assets is to insulate the portfolio – they should rise in value in periods of market stress, when other assets are struggling.

The protective toolkit of assets traditionally includes US government bonds, the yen and gold.

This month’s Green Line shows how these safe-haven assets performed during previous periods of market stress.

Until this year, they have performed consistently well, acting as a shock absorber for portfolios. This has been true whether the market stresses were financial, political, global or local.

For example, in 2011, the crisis centred on the credit rating downgrade of the US government – yet US Treasuries still offered protection. In an ancillary blessing, these assets have also delivered strong returns to investors outside of crisis periods too.

Yet in February 2018, during a sharp market sell-off, each of these traditional protections misfired. As a result, conventional balanced portfolios had nothing to cushion their fall.

At Ruffer, we believe conventional balanced portfolios are now far riskier than they are generally perceived to be. This year, investors should think carefully about how their portfolio might perform should markets deteriorate.

We have been concerned about this risk for some time, and have put alternative safeguards in place to preserve our clients’ capital in the next market downturn. Investments with returns linked to a rise in market volatility, and to higher corporate borrowing costs, are giving us the protection we seek.

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Japan: a forgotten market?
March 2018: Japanese shares have risen strongly, but not nearly as much as company profits.
Misplaced confidence?
February 2018: US consumer confidence is very high. Our analysis suggests this is not good news for investors in equity markets.

Chart source: Bloomberg and Ruffer calculations, data applies to a two week period following each event.

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