The capital market is home to asset classes that come with varying degrees of risk. While others are deemed high risk, others come with low-risk profiles. Therefore, it is common to hear investors terming some investments riskier than others. Safe Havens and funding currency are special asset classes cherished for their risk profile.
Understanding safe-haven
A safe haven is a financial instrument that investors turn to in times of uncertainties and crisis. They are deemed less risky as they tend to retain or increase in value as other asset classes get clobbered.
In times of crisis and financial uncertainties, investors tend to allocate most of their capital to safe havens in a bid to protect wealth. Therefore, such assets act as storage of value as they tend to outperform the overall market amid the uncertainties.
Features
Strong economies with a trade surplus back most if not all safe-havens. Coins considered as a store of value are mostly of countries with stable and strong economies. The US, Switzerland, and Japan are some of the countries whose economies are extremely stable.
Besides, an asset would be deemed a safe haven if it is not susceptible to economic and political uncertainties. Instead of such assets depreciating in times of crisis, they tend to stay substantially at the same level or appreciate, thus, offering perfect storage of wealth.
Examples
Let us now look at the three instruments that enjoy the highest popularity among investors in crises and analyze the reasons for their safe-haven status.
Gold
Gold has proven to always be stable and less volatile; thus, the reason it is considered a store of value. Unlike money, it cannot be printed or affected by any economic developments, let alone monetary policies. Likewise, the precious metal tends to retain its worth over time regardless of the situation.
People tend to rush to the yellow metal whenever riskier investments are underperforming or are under immense pressure. It’s for this reason that it’s always been deemed as insurance against adverse developments.
The bullion’s worth tends to increase in times of high inflation as it is priced in US dollars. Conversely, it is common to find people using it, to hedge against a spike in inflation.
Currencies
Some legal tenders are also deemed as a reliable store of wealth in times of uncertainty. It is common to find investors converting their holdings into these legal tenders whenever there is fear of turmoil in the market.
The Swiss franc attracts lots of investments whenever fear grips the stock markets. The fiat is considered a haven partly because of the stability of Switzerland’s economy. The country also boasts of a stable financial system that has always shown resilience to shocks that grip the global financial system.
In times of uncertainty, the Swiss franc often experiences pent-up demand in the forex market as investors exit positions in riskier assets. A large, stable, and safe banking industry has always helped strengthen Swiss francs sentiments among investors.
The US dollar has often been deemed a haven for navigating the financial and economic crisis. Its edge as a store of value stems from the fact that it is backed by one of the biggest and most stable economies.
Companies facing domestic currency uncertainty often turn to the greenback to lock in some value on their capital holdings, given its stability and ability to lock in the value. Unlike other instruments, the buck is immune to wild swings due to economic or financial pressures.
The yen is another option as a store of gains for navigating uncertainties in the global financial and stock markets. Japan’s political and financial stability has always strengthened its edge as a safe bet in times of crisis.
Funding currencies
Funding currencies double up as safe-havens. They are considered for funding partly because they come with low interest rates as compared to high-yielding assets. Conversely, individual and institutional investors use them to raise cheap capital.
The low interest rate they come with makes it cheaper to borrow capital that can be invested in high-yield currencies. The Japanese yen is a perfect example, in this case, given the low interest rates that have dominated the Japanese economy.
Likewise, it is common to find investors and corporates raising capital through the yen, which is conversely invested in high yields such as Australia and New Zealand, whose economies have been dominated by the high interest rates. The Swiss franc, which also acts as a store of value in crisis times, also doubles up as funding currency given Switzerland’s low interest rates.
While safe-havens tend to underperform in times of high economic optimism and increasing equity prices, so do funding coins. In contrast, during uncertainties and financial crises, funding currencies attract lots of bids and outperform the overall market.
Their role
Safe havens and funding currencies play an important role in investment portfolio diversification. Instead of having everything on riskier assets, it is prudent to also allocate some funds to instruments that are immune to uncertainties or shocks.
In addition to diversifying an investment portfolio, the two asset classes can be extremely beneficial in times of market volatility. As some economic events or developments trigger extreme volatility levels that at times take a toll on riskier investments, these instruments tend to remain resilient, ensuring the portfolio does not fall sharply.
The future
The assets that have traditionally operated as safe-havens are under immense pressure with the emergence of new asset classes that people are starting to use as a store of profits. The US dollar and Swiss francs dominance of the space is under threat more than ever.
The rise of China’s economy has seen the Chinese yuan’s emergence as a store of value in recent years. Likewise, the emergence of cryptocurrencies and their transition into the mainstream financial sector is increasingly fuelling the suggestion that some could act as a perfect store of value. The fact that digital assets are not subject to economic or monetary policies sees them attract strong interest as they are not prone to manipulation.
