What are safe havens?
When financial markets are in crisis, like they were in late February through mid March or during the Global Financial Crisis of 2008, investors tend to flock to assets that they consider safe and high quality. Safe-haven assets are those that have tended to perform well in volatile market environments. While most investments are sinking, these assets tend to maintain their value, appreciate, or otherwise outperform during crises. However, what might have been considered a safe haven in one market crisis might not be in the next, and it’s hard to know ex-ante which assets will behave as safe havens in future market crises. Over time, investors have developed a sense of which assets might be expected to behave as safe havens, and in this post, we’ll look at five of those assets and evaluate their performance during the COVID market crisis.
How are we defining the COVID market crisis?
The crisis relating to the spread of the novel coronavirus is ongoing, and its true end date is unknown at the time of this publication. However, we define the dates for the COVID market crisis period as starting with the first day of losses in the global Equity factor (February 20th) and ending at the peak losses on March 23rd. It is intended to represent the hardest and sharpest part of the equity market decline thus far. We chose the global equity market as a proxy to determine the crisis period because (1) the crisis is global in nature, and (2) equity risk dominates most portfolios. When equity markets decline, investors typically flock to the safer assets we’ll be discussing.
Exhibit 1: Cumulative Return of the Equity Factor
Source: Venn as of May 15, 2020. Time period: January 1, 2020 - May 14, 2020.
- Government Bonds
Developed market sovereign bonds are arguably the most canonical example of a safe-haven asset because of their lower realized volatility relative to stocks and the high expected creditworthiness of their issuers (developed market governments). The below exhibit showcases the returns of 10-year government bond futures (in local currency terms) in six major developed markets. Almost all posted positive returns over the COVID market crisis period, with the two exceptions being European and Japanese bonds, where yields actually increased slightly. U.S. government bonds were the top performers, as yields dropped precipitously over this period.
Across countries/regions, the bonds were positively correlated, all following a similar path. In the first few weeks of the COVID market crisis, when risk assets were collapsing, the bonds behaved as expected: yields dropped as central banks cut interest rates and investors ditched risky assets for relatively less risky government bonds. However, a turnaround started around March 9th, as the dramatic market panic picked up in terms of intensity and investors rushed out of long-term sovereign debt to raise cash in order to meet margin calls and other liquidity needs.1 The bonds reversed course again around March 18th -19th, and rose for the rest of the period.
Exhibit 2: Cumulative Returns of 10 Year Sovereign Bond Futures
Source: CSI and Venn as of May 11, 2020. Time period: February 20, 2020 - March 23, 2020.
Many consider gold, a precious metal, to be an attractive asset to hold in portfolios for a variety of reasons:
- Its liquid market makes it relatively easy to buy and sell
- It’s a hard asset with real world uses and has served as a traditional medium of exchange
- It provides a source of diversification to equity-dominant portfolios (gold’s historical correlation with the Equity factor is ~0.05), and
- Historically it has performed well in market selloffs (for example, gold returned over 20% during the sharpest part of the Global Financial Crisis: September 15, 2008 - March 9, 2009)2
Although gold did not provide the same level of relief during the COVID market crisis that it did during the Global Financial Crisis, its -2.74% return outperformed equity markets and other commodity sectors, such as energy.3
As shown in Exhibit 2, gold’s performance reversed course a few times, but the most notable reversal was a drop in early to mid-March. A possible explanation for the drop was that gold fell victim to panicked selling by investors,4 in which margin calls on leveraged positions sparked a “dash-to-cash”.5
Exhibit 3: Cumulative Return of Gold
Source: CSI and Venn as of May 15, 2020. Time period: February 20, 2020 - March 23, 2020.
We’ll explore three currencies -- the U.S. dollar, the Japanese yen, and the Swiss franc -- that investors have traditionally considered to be safe havens, as they have a mix of characteristics that make them attractive to hold in times of market uncertainty. These include:
- The backing of a stable political system
- The backing of a country or region with strong finances and economic growth prospects
- Liquid markets
- The tendency for foreign governments to hold the currency in reserves, and
- High confidence in the creditworthiness of the country or region that issues it
Exhibit 5 displays the performance of the three currencies, using the MSFX indices relative to USD for the non-USD currencies and a U.S. Dollar index for the USD. The path of returns is interesting across these currencies: the non-USD currencies held up relatively well early on in the COVID market crisis, as falling yields in the U.S. weakened the USD’s appeal.6 However, there was a reversal around March 9th (around the same date that we saw reversals in the other safe-haven assets mentioned above). From this point forward, the USD outperformed, ending the COVID market crisis (as we’ve defined it) above all other safe haven currencies. This reversal underlies the aforementioned “dash-for-cash” behavior, as investors flocked to the USD and liquidated their investments in other assets. USD cash-raising appeared to outweigh that of the other currencies, perhaps due to the USD’s status as the primary global reserve currency and several countries’ reliance on USD access to manage their economies during the COVID pandemic.7
Exhibit 4: Cumulative Returns of Currencies
Source: Morgan Stanley, CSI, and Venn as of May 13, 2020. Time period: February 20, 2020 - March 23, 2020.
- “Defensive” stocks
While stocks typically might not be considered safe-haven assets, certain pockets of the equity market might be expected to outperform during market turmoil. Some examples include sectors such as Utilities, Consumer Staples, and Healthcare. The thinking here is that no matter the state of the markets, people will still need access to electricity, gas, and power; people will still be purchasing staple items like food (and toilet paper, as we’ve learned during the COVID market crisis!); and people will still need access to health care. How have these three sectors held up during the COVID market crisis from a global perspective?
As seen in the chart below, the Consumer Staples and Healthcare sectors outperformed the global equity market, while Utilities slightly underperformed. Potential reasons for the underperformance in Utilities are that:
- Even though individuals and families were certainly using utilities, especially with widely mandated stay-at-home orders, utility companies that have commercial or industrial customers had more downside risk overall, as factories shut down, sporting events were canceled, construction projects paused, etc.8
- Investors have been attracted to utility stocks because of their propensity to pay relatively high dividends. High-yielding stocks generally underperformed during the COVID market crisis,9 perhaps as investors priced in announcements from many companies of cuts to their dividend programs in an effort to preserve cash.10
Exhibit 5: Cumulative Excess Returns of Global Equity Sectors Relative to the MSCI ACWI11
Source: Morningstar and Venn as of May 14, 2020. Time period: February 20, 2020 - March 23, 2020.
What about from a factor perspective? How did “defensive” factors such as Quality and Low Risk perform over this period? We’ve already written quite a bit on this, using the equity style factors in the Two Sigma Factor Lens (read our Venn Factor Performance Reports and an e-book on factor performance during three crises, including the “Coronavirus Crisis”). To summarize, Quality was a strong performer, experiencing gains from three of its five components: Leverage, Profitability, and Earnings Quality.12 Low Risk, on the other hand, struggled quite a bit, with losses coming from both its Beta and Residual Volatility components.13
Finally, Bitcoin, a digital currency, is considered by some to be a safe-haven asset in that it is decentralized and isn’t at risk of being seized or inflated by a government. However, a case could be made against Bitcoin’s safe-haven label, as the market for Bitcoin is highly speculative and unregulated, the cryptocurrency does not represent a claim on any underlying hard asset, and it’s not backed by a sovereign government entity.
Bitcoin did not perform like a safe haven would be expected to during the COVID market crisis period. In fact, its cumulative return was -33.27%, and it took a particularly bad hit on March 12th, which represented the largest one-day drop in Bitcoin since 2013.14
Coinbase, a digital currency exchange, wrote a blog post explaining what happened on that date, citing the massive risk-off move and deleveraging that occurred in financial markets, following the World Health Organization’s labeling of the COVID-19 outbreak as a pandemic and a travel ban instituted by the U.S. The reason Bitcoin in particular was hit hard was because of the high amount of leverage in the Bitcoin industry (derivatives exchanges can offer up to 125x leverage).15 Others, like Multicoin (a crypto investment firm), claim that the immaturity of Bitcoin’s existing market structure, including the multitude of trading venues with varying market mechanics, make it extremely difficult for arbitrageurs to correct prices during crisis periods, causing massive dislocations.16
It’s worth mentioning that Bitcoin posted strong returns in the period following the COVID market crisis (+44.22% cumulative returns from March 24, 2020 - May 6, 2020), during which equity markets also broadly rallied. In fact, Bitcoin has exhibited a positive correlation with the global Equity factor of 0.7 during the COVID market crisis and period immediately following. Given the cryptocurrency’s markedly high correlation with global equity markets during this period, and propensity to tumble during the height of the crisis, it’s hard to consider Bitcoin a safe-haven asset during the COVID market crisis and subsequent recovery period.
Exhibit 6: Cumulative Return of Bitcoin
Source: Bloomberg and Venn as of May 20, 2020. Time period: February 20, 2020 - March 23, 2020.
Safe-haven assets are defined as those that maintain their value, appreciate, or otherwise outperform when financial markets crumble. However, a safe-haven asset isn’t guaranteed to produce positive returns in all market downturns. Here we took a look at five types of potential safe-haven assets and how they fared during the worst period for equity markets during the recent COVID market crisis.
We found that most of the safe havens we examined held up notably better than the global equity market during the COVID market crisis period. Many sovereign bonds, the USD, and certain equity sectors and styles generated positive returns overall, while others, such as gold and certain non-USD currencies, were flat to marginally down. Bitcoin saw the worst performance of any of the “safe-haven” assets we examined, experiencing a -27.19% crash on March 12th and exhibiting a generally positive correlation with global equity markets throughout the crisis and subsequent recovery period.17
Many of the purported safe havens were affected by a “dash-to-cash” behavior that occurred in mid-March. When the market panic really intensified, and investors indiscriminately liquidated holdings to raise cash, even the seemingly safest assets weren’t spared.
While all of this ex-post analysis is helpful in that it provides us with an understanding of asset performance during this highly unusual time, it unfortunately doesn’t help investors predict which assets will outperform in the next market crisis. We believe that every market crash is unique and the safe-haven assets that emerge in the next crash will likely depend on the specific conditions of that market crisis.
1 Source: Financial Times article “A strategy for the dysfunctional US Treasuries market” on March 22, 2020.
Additionally, read the Two Sigma Street View, “Unwinds, Diversification, and Constraints: The Mechanics of Financial Panics” for more information on the deleveraging in March 2020 and general financial panic mechanics.
2 Source: Commodity Systems Inc. (CSI) and Venn as of May 21, 2020.
3 Gold also entered positive territory in the period immediately following the COVID market crisis, returning +6.52% from March 24, 2020 through May 6, 2020.
4 Source: Barron’s article “Future Returns: Why Gold is Still a Safe Haven Asset” on March 17, 2020.
5 Source: Financial Times article “Hedge fund bets hammered as industry retrenches amid cash dash” on March 19, 2020.
6 Sources: Reuters article “Dollar hammered as U.S. Treasury yields sink” on March 5, 2020 and Axios article “The coronavirus outbreak could finally sink the dollar” on March 6, 2020.
7 Sources: Financial Times article “Dollar liquidity measures leave some countries out in the cold” on May 17, 2020 and Foreign Affairs article “The Future of the Dollar” on May 19, 2020.
8 Source: S&P Global Market Intelligence article “S&P sees increased risks for certain utilities from coronavirus, recession” on March 19, 2020.
9 Source: Venn.
10 Source: S&P Global article “Why Did Dividend Indices Underperform during the Coronavirus Sell-Off?” on May 19, 2020.
11 Sectors are represented by their respective iShares Global ETFs. Returns are relative to the iShares MSCI ACWI ETF.
12 Source: Venn.
13 Source: Venn.
14 Source: Bloomberg ticker XBTUSD, the Bitcoin / USD cross.
15 Source: Multicoin Capital blog post “March 12: The Day Crypto Market Structure Broke (Part 1)” on March 17, 2020.
16 Source: Multicoin Capital blog post “March 12: The Day Crypto Market Structure Broke (Part 1)” on March 17, 2020.
17 Sources: Bloomberg ticker XBTUSD, the Bitcoin / USD cross, and Venn as of May 20, 2020.
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