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Investors Prefer to Reduce Risk by Coming Home

Friday, 18 October 2013 11:16 AM

The U.S. debt scare may be changing the perception of what's considered a safe asset, with investors increasingly seeing home as the haven.

In the run up to the Oct. 17 deadline to raise the U.S. debt limit, classic go-to "safe" assets such as the Swiss franc, gold or top-rated non-U.S. government bonds drew few anxious inflows.

However, those who moved to protect portfolios did sell Treasuries, traditionally the No.1 safe haven asset, ditching the short-dated maturities most vulnerable to the chance of missing payments. U.S. money market funds exposed to such paper also saw the biggest outflows in two years.

Others, including Japanese investors, brought money home to park funds in liquid, familiar markets that have no currency risks or additional transaction costs.

And this reinforces an emerging trend of conservative investors gradually reducing overseas holdings to limit risk against the backdrop of an aging population. This is a move that benefits developed markets, home to nearly $56 trillion, or 70 percent of the world's institutional assets.

"What is a safe haven? You're looking for where you have the security of the underlying economy and political establishment and where you can get in and out of that investment without crossing a massive bid/ask spread," said John Bilton, head of European investment strategy at Bank of America Merrill Lynch.

Japanese investors have been most prominent in repatriating their overseas holdings, offloading nearly $23 billion of foreign bonds on a net basis in the week to Oct. 5.

As debt fears escalated, European fund managers pulled money from emerging Asian and U.S. stocks in September and boosted equity holdings at home where growth momentum is accelerating, according to the Reuters monthly fund managers' survey.

Europe-based investors boosted local equity weightings to 32.4 percent, levels not seen since October 2011.

UK-based investors pushed domestic equity holdings to 23.4 percent from 22.7 percent in August while in Japan, domestic equity holdings are at the highest level in at least a year.

Aging societies and tighter regulation are prompting many investors to scale back their overseas investments, partly to align their assets with liabilities.

Anthony Deeley, pension trustee of UK-based engineering company GKN, says the priority of one of the company's pension schemes that is closed for new entrants is cutting risk and sterling-denominated home assets play a significant role.

The average age of this pension scheme's members is 78.

"We do pay pensions in sterling, so assets valued in sterling are much easier to manage partly because we don't have to have currency hedging. It makes life much easier," he said.

In Britain, the share of domestic sovereign debt has risen four-fold to 35 percent in 2011 since 1994. The share of overseas securities peaked at 35 percent in 2007 before falling to 29 percent in 2011.

"By expanding your portfolio abroad, you will also add currency risk volatility to your portfolio and as we see it, we are not systemically compensated for taking that risk," Tomas Franzen, chief investment strategist at Second Swedish National Pension Fund, said in a report published by Clear Path Analysis.

Within developed markets, home-biased flows are likely to benefit Japan and Europe, where the population is aging faster than in the United States.



In the run up to the Oct. 17 deadline, classic risk reduction through rotation from equities to bonds was not obvious either.

Bilton said bonds may no longer be enjoying a safer status than equities. According to BofA's calculations, the Sharpe ratio - a measure of the excess return per unit of risk - of bonds is now lower than that of equities for the first meaningful period since 2006.

"Bonds are riskier than equities for the amount of risk you get, and that's very unusual. That inversion questions what is the safe haven," Bilton said.

© 2020 Thomson/Reuters. All rights reserved.

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The U.S. debt scare may be changing the perception of what's considered a safe asset, with investors increasingly seeing home as the haven.
Friday, 18 October 2013 11:16 AM
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