'Safe' investing in times of uncertainty

The original version of this article first appeared in The Business Times. ‍

Geopolitical events seem unprecedented because they are largely unpredictable, and the factors that trigger them rarely happen in the same way twice. 

What is consistent is that these tensions and uncertainties always prompt plentiful bets on which investments are “safe”, and which are not. 

Traditionally, the US 10-year treasury, the US dollar, and selective commodities such as gold and oil, have been considered safe-haven assets. Gold, in particular, has a reputation as a store of value. In times of geopolitical instability, when the value of paper currency and other financial instruments can be volatile, gold’s intrinsic value is perceived to be more stable. This batch includes currencies such as the Japanese yen against the US dollar, and the Swiss Franc against the Euro. 

However, in a research by Goldman Sachs that looked at 12 historical geopolitical events over the last half-century, the findings showed that the ability of various safe-haven assets to offer downside protection has been far from consistent, between a myriad of geopolitical events. 

Source: Goldman Sachs

What investors ought to remember is — despite being touted as “safe,” the returns (and losses) of such assets can vary, in some cases by a large margin. Depending on the time you purchased these assets, the results could turn out to be even more unfavourable.

Why these “safe-haven” assets may not perform the way we think 

Gold has a special place in the hearts of investors, especially in emerging markets where currency has been volatile, and political risk has been high. 

But because gold does not actually earn a yield, it is not easy to figure out what the “intrinsic value” of the asset should be. It also has long periods of muted performance. History shows us that it took almost 9 years from its peak in September 2011 to return to the same levels in 2020 — the same period in which the S&P 500 Index went up nearly three times. 

Comparatively, oil has performed worse than gold in the absence of geopolitical tensions and supply shocks. Over the last 20 years, Brent has annualised a return of 3.5%, and if bought at the tail-end of geopolitical events (for instance, at the February 2022 peak after Russian invasion of Ukraine) investors could have lost more than 30% of their principal.

What about US treasury bonds? Although considered to have practically no credit risk, it does, however, have interest rate risk and depending on the maturity of the bonds, duration risk. 

The S&P US Treasury Bond Current 10 Year Total Return Index returned minus 25% between July 2020 to October 2022. An investor who blindly thought US treasury bonds were “safe” through any market cycle may have been surprised during this period. Conversely, during the Great Financial Crisis, the same index rose 21% in 2008, proving to be a good diversifier to equities.

Cash is likely considered the most stable asset in times of crisis — but we have seen time and time again how cash can eat into real purchasing power as it fails to protect against inflation. 

Taking the latest example in Japanese Yen: not only has the currency depreciated against the US dollar (and Singaporean dollar) to the lowest level in recent history, it has shown extreme volatility. The US dollar itself – expressed as a currency against a basket of all other currencies or U.S. Dollar Index, DXY – has also historically been an unreliable “safe haven” for investors with assets and liabilities outside of the US.

To de-risk or not?

When geopolitics makes the front page, market commentators and participants claim they know how to navigate the markets. Yet, the reality is that many people panic at the first sign of trouble, feeling compelled to take action even when their investment goals and appetite for risk have not really changed from the time they were first set. 

Reflecting on the past three years alone, we've traversed a chapter of many “unprecedented” events that have sent market sentiment from one extreme to another. 

From the depths of despair during the Covid-19 pandemic and the subsequent flood of liquidity, to the journey from transitory inflation to a stubborn, higher-for-longer inflation narrative. We have witnessed the quickest pace of interest rate hikes in history, igniting fears of recession, debates over the nature of the economic landing – hard, soft, or perhaps none at all – and now, a return to concerns over persistent inflation. This tumult unfolds against a backdrop of ongoing conflicts and escalating geopolitical tensions around the world.

When we juxtapose these tumultuous times with market performance, a different picture emerges. Over the last five years, despite the myriad changes and challenges, the global stock market, as represented by the MSCI USD Total Return Index, has achieved an annualised return of 9.7%. Meanwhile, global bonds, tracked by the Bloomberg Global Aggregate USD Total Return Index, have posted a modest annualised return of 0.5%.

To capture that 9.7% annualised equity return over the past five years, one would have had to be “in the markets” through thick and thin for the entirety of that period. Attempting to time the market by frequently trading in and out during these volatile periods would have substantially diminished the chances of achieving such a return.

Learn from the legends

“Everyone has a plan ‘till they get punched in the mouth.” This is one of my favourite quotes from the legendary boxer, Mike Tyson. Though not originally about financial markets, I think it is equally applicable to investors, novice and experienced alike.

This “punch” in our investing journeys can look different, but the quote vividly captures the essence of how unforeseen events can abruptly challenge our strategies and plans. 

Endowus gets its name from “Endowment investing for all of Us”. At its core, the investment philosophy is about goal-based investing and, by extension, structuring investment portfolios such that they meet the short-term and long-term goals on an inflation-adjusted (or real) basis. 

In practical terms, short-term goals will be invested in asset classes which have little or low chances of drawdowns, while long-term investment goals can afford to take on more risk. This is usually achieved through diversification by region, sector, and various asset classes. 

One should not be trying to predict when the market might throw us the “punch.” The possibility of large drawdowns in markets would have already needed to be considered ahead of time and factored into asset allocations, rather than being “reactive” to every market shift. 

So, how do the best endowments invest in times of high volatility? The real answer is no secret and the truth is they usually invest no differently from times of low volatility. They adhere to the same disciplined, goal-based, long-term plan. 

A prudent strategy in uncertain times

Ultimately, chasing safe-haven asset classes at the first hint of market volatility is closer to speculating than investing. 

To mirror the approach of the best endowments and institutional investors, especially during periods of volatility and geopolitical uncertainty, it’s crucial to establish investment objectives, assess risk tolerance, diversify your portfolio, maintain disciplined investing practices, and be vigilant about investing costs.

A prudent way of investing during times of increased volatility is a return to the discipline of the dollar cost-averaging — investing a fixed sum of money at regular intervals, regardless of the asset's current price. 

Living in the uncertainties of today may seem overwhelming, but the enduring principle holds true: there are potential rewards for those who remain dedicated to a risk-appropriate investment plan. Once you have done this, the best course of action in times of uncertainty is more likely than not to simply do nothing, and let the market do its work.