Last updated: February 22, 2011 3:34 pm

Safe assets: nowhere to hide

Flight to safety

The strife in Libya is a good reason for investors to go “risk-off”. There are many others: high levels for fiscal deficits, inflation and debts, freakily low policy interest rates, poor global co-ordination, possible Chinese property and commodity bubbles, and even an earthquake in New Zealand. Scary stuff, but where can safety-searching investors go?

They are not turning to gold, often considered the ultimate refuge asset. The price fell on Tuesday and is about where it was three months ago. This is reasonable; after doubling since the 2008 trough, gold looks like a beneficiary of too loose monetary policy.

The dollar rose on Tuesday, but this traditional safe haven is now a play on an over-indebted country with declining global influence – exemplified by its inability to influence events in the Middle East. The price of US Treasuries, the classic “risk-free” asset of financial theory, also rose on Tuesday. But the yield of 3.5 per cent on the 10-year bond does little to guard against the real risk that inflation will erode it.

Equities are considered “risk-on”, but if inflation is the danger, these real assets probably belong in the safer camp. They produce cash flows that should rise over time. But stocks can never seem secure to investors (especially leveraged ones) who think risk is measured by price volatility.

It is easy enough to protect a portfolio against this or that risk. Worried about high oil prices? Buy oil (and make the problem worse). Inflation? Deflationary Japan could work. Geopolitical shifts? China is the winner. Bubbles? Short everything Chinese. And so forth.

But absolute safety in investment is a chimera. Too many events that change asset values are either almost unpredictable (falling Middle Eastern governments) or almost unbeatable (monetary debasement). Even if investors will accept low returns in exchange for low risk, history suggests they will get a bad deal. Better to concentrate on identifying controllable risks – and to accept that the world is full of troubles.

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