Stuart Fowler: protecting wealth with so few safe havens

As managers of private wealth, our clients leave us in no doubt about what they see as the most vital responsibility we have to them: to ensure the family’s capital can survive the worst that the world economy can throw at them.

When planning an investment strategy with new clients, this kind of stress test can seem slightly academic. Not today. The break-up of the eurozone is seen by many of our clients as inevitable and it consequences as catastrophic. The words ‘apocalypse’ and ‘armageddon’ have also been used.

If there is indeed a lethal threat to the capitalist system and hence to their welfare, it is more about debt than equity. Debt was the origin of the banking crisis that began in 2008 and is at the heart of the eurozone crisis that it exposed.

It is therefore entirely intuitive that the investment strategies we adopt to preserve real wealth, at any level of risk tolerance, exclude all holdings of conventional bonds, sovereign or corporate.

Our exposure to debt issuers is limited to the UK government in the form of index-linked gilts and inflation-indexed National Savings certificates. The government is effectively also the debtor behind our clients’ insured bank deposits.

Avoiding conventional bonds is intuitive but also perfectly rational. In the particular circumstances the world economy finds itself in, we clearly cannot exclude the possibility of either deflation or high inflation. One of the greatest bond bull markets ever has left conventional bonds extremely vulnerable to both risks. 

Governments may not be able to prevent the forced liquidation of excessive levels of debt, causing a vicious cycle of falling prices and incomes that mean debts cannot be serviced or repaid in full.

Ten-year gilt yields of around 2% have almost never been this low. They imply a high probability of this ‘debt deflation’ but the additional 2%-3% yield on the small population of high grade, sterling-denominated corporate bonds is not enough to guard against its consequences.

To the extent that monetary policies aimed at averting debt deflation eventually lead to high inflation and currency collapse, we might even experience both, in sequence.