Apart from gold, what should be your top safe have asset picks?

Human history is filled with stories of searches for safe havens.

Early explorers found havens from storms and raiders in friendly harbours. Human migration has been directed towards physical safe havens when threatened by fallout from conflict. It is no surprise that financial market investors, too, seek safe havens when investment portfolios are threatened by shocks, volatility or other sources of losses.

No perfect haven

A safe haven financial asset is one that maintains its value, or even rises in value, when market volatility rises and major risky assets fall. Financial markets offer a range of such potential safe havens. Gold is a favourite, with possibly the longest history of safe haven demand.

Equities have defensive sectors which deliver relatively stable earnings through good times and bad. High quality government bonds can offer a safe haven. In currency markets, the US Dollar (USD), Swiss Franc (CHF) and Japanese Yen (JPY) have performed best during uncertain times.

What makes a safe haven?

It is often argued that the USD, CHF and JPY act as safe havens because their markets offer key safety characteristics, including political stability, economic strength, financial market depth and low inflation.

The USD makes a strong case for itself in these terms – most global investments are still USD-denominated, which means that, at times of market volatility, many such investors withdraw to the relative safety of the USD, thereby reducing currency risk in their portfolios.

Looking beyond the USD, one can argue the qualities described above are available in a wider range of currencies beyond just the JPY and CHF. However, this is where we rely to some degree on observed behaviour.

During the 2008-09 Great Financial Crisis, for example, the S&P500 peaked on October 11, 2007 before selling off sharply. From this date, the JPY and the CHF gained almost 17% against the USD till their near-term peak in mid-March 2008. Similarly, the JPY and CHF gained 11% and 7% trough-to-peak against the USD as the COVID pandemic broke out in the first quarter of 2020.

Indeed, a 2013 study by the IMF found that the JPY behaved like a safe haven currency over time, with changes in perception of risk by global investors driving such flight-to-safety behaviour.

Adding havens to a portfolio

Safe haven currencies can play a useful role in investment portfolios. While they are not meant to be a key source of long-term return, they can add stability during periods of volatility and help preserve dry powder to take advantage of pullbacks in risky assets.

Two notes of caution are warranted, though. First, while the idea of a safe haven is tempting, a long history of financial markets shows us that there is no such thing as the ‘perfect’ safe haven. There has been at least one instance where each so-called safe haven asset class has fallen in value during elevated market volatility and, therefore, failed in its role as a safe haven.

Thus, safe haven currencies can be part of an overall basket of safe haven assets which can help lower an investor’s portfolio volatility in times of uncertainty.

The second is related to time horizon. Many safe haven assets, including currencies such as the JPY and CHF, help mitigate weakness in risky assets over relatively short periods of time. Each risk event is different to some degree, so investors need to assess each incident separately and not wait too long in taking profit on any safe haven gains.

A useful investor tool

Safe haven assets may not always be a key source of long-term return, but they are useful tools for investors to add stability to a portfolio during times of market volatility. While there is no perfect safe haven asset, currencies such as the USD, JPY and CHF can be a valuable component of a basket of safe haven assets within a diversified portfolio.