Crisis rewards safety-first strategy
Complex financial products were all the rage before the credit crunch first started to bite investors half a decade ago.
Since then, decidedly staid, simple assets have been on a tear – gold, grain and government bond returns have led the way.
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“There’s been a lot of lost face in asset allocation over the past five years,” says Michael Turner, head of global strategy and asset allocation at Aberdeen Asset Management. “Who would have thought that [government bond] yields could have gone so low?”
Investors heading towards the safest and most liquid assets they can find have piled into the debts of the US, Germany and the UK, leading to cumulative returns of 38 per cent, 26 per cent and 19 per cent in US dollar terms over the past half decade, according to Deutsche Bank.
Even this has paled next to the five-year returns of corn, gold, silver, oil and wheat. Corporate debt has also done well, with US corporate bonds returning 44 per cent overall. European junk bonds have returned 26 per cent in US dollar terms.
By contrast, stock markets have languished. Even in the US, one of the better performing markets, investors have pulled more than $500bn from equity mutual funds since May 2007.
However, investors and strategists say the assets that have proved winners over the past half decade are unlikely to replicate their returns over the next five years.
Although government bond yields are likely to stay low for an extended period and could even dip further, few expect the superlative recent returns to continue.
Similarly, investment-grade corporate bonds have also benefited from “haven” flows but yields are now extremely subdued, even if the spreads over benchmark government bonds are still higher than before the crisis.
If inflation picks up, it will erode the returns of safe but low-yielding fixed income, investors warn. “At some point in the future inflation has to pick up and bonds won’t be a good investment in that environment,” says Robert Farago, head of asset allocation at Schroders Private Bank.
Gold and silver have benefited from their status as an “alternative” currency that cannot be debased by central bank bond-buying.
But after the dramatic gains of the past half decade, investors are increasingly concerned that the precious metals bull market may have run its course.
Moreover, investors may have struggled to profit from the surge in commodity prices. While some have rallied, others, such as US natural gas, have fallen in price.
Investors in commodity futures have also been punished by being forced to move their positions from expiring futures contracts to later dated ones – an effect known as “negative roll yield”.
While the S&P GSCI, the most widely invested commodity index, has seen a 34.8 per cent increase in its spot value since August 2007, investors in it would have lost 19.3 per cent due to the negative roll effect.
“On the face of it you can say all we needed to do was pick gold and corn and everything would have been fine and dandy,” says Kevin Norrish, senior commodities analyst at Barclays. “In actual fact it is a lot more complicated.”
Increasingly, investors are questioning whether the bull market “supercycle” may be nearing an end, as China shifts from an infrastructure-heavy period of growth to one led by consumption – and a period of slower economic expansion overall.
Indeed, some investors fear emerging markets could be the global economy’s next soft spot.
Stephen Jen, founder of macro hedge fund SLJ Macro Partners, believes the world is now entering the third stage of the financial crisis, which he argues has moved from the US to the eurozone and is now playing out in developing economies.
“For four years, credit cycles in emerging markets have been powered by monetary easing in developed economies but that cannot last forever,” he says.
“This is the first time we’re seeing soft data in all three time zones. I find that very disturbing and I think policy makers around the world are also quite scared.”
Yet despite the gloomy outlook, many investors argue that one of the riskiest assets – equities – could begin to regain their lustre over the next five years, particularly if the eurozone manages to avoid economic and financial catastrophe.
“Equities are my asset class, so it’s natural for me to be bullish, but no matter how I look at it, the only way equities don’t beat bonds is in a new depression,” says Robert Doll, senior adviser at BlackRock.
“This is a probability game and the probabilities clearly favour equities,” he adds.
“Even if we don’t see the real equity returns of the past century, even half of that would beat most other asset classes now.”