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Asset Allocation: RBC on how to manage the death of safe havens

by George King on Nov 28, 2012 at 00:01

Asset Allocation: RBC on how to manage the death of safe havens

The markets over the past year have presented a series of challenges that have undermined the effectiveness of asset allocation in the near term.

The principal benefits of portfolio asset allocation – broadening the opportunity to generate gains and to reduce risk through diversification – have been rendered much less effective for a couple of reasons.

First, the European debt crisis risks and the ongoing slow growth and debt deleveraging cycles in developed nations have meant the actions of central banks and governments have primarily shaped the performance of financial markets, overshadowing corporate earnings and economic results.

Moreover, many investable assets have been deemed ‘risky’ by the markets and have tended to become more correlated, significantly eroding the value of crafting asset allocation strategies in the first place. Given these adverse circumstances, many investors preoccupy themselves with a ‘flight to safety’ in an attempt to preserve their wealth.

The elusive search for ‘safe assets’

Market developments over the last year have fundamentally altered the market’s perception of the concept of a ‘safe haven’.

The budget stand-off and ratings downgrade in the US last year; central bank interventions impeding the Swiss franc; wholesale ratings downgrades of AAA and AA corporates and countries; and gold failing to perform in the midst of the type of market and political uncertainty for which investors hold the asset – all these developments have made it difficult to consider any asset to be a true ‘safe haven’.

Instead, the issue is one of relative safety, and from which risks.

In the now bygone era when safe haven investments could often be counted on to produce a return that might at least keep pace with inflation, the downside to being safe was simply the opportunity cost of generating higher returns.

However, in an environment where safe assets are defined solely as being expected to provide capital preservation, the risk of wealth erosion due to inflation and other factors (such as taxes and fees) should be a primary concern for private clients and their wealth managers. 

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