Not all bonds are the same. But are any of them safe havens?

Government bonds shouldn’t be considered a safe haven asset, says Anthony Rayner, manager of Miton’s multi asset fund range.

Government bonds shouldn’t be considered a safe haven asset, says Anthony Rayner, manager of Miton’s multi asset fund range.

To say that not all bonds are the same is stating the obvious but to suggest that government bonds shouldn’t be considered a safe haven asset, is a little braver.

To make both points, we compare two extremes – Argentina and Austria. Both are hundred year bonds, both were launched in 2017 and both were issued by governments, rather than companies. The similarities end there. The main difference is that the Austrian economy is a developed economy, with broadly sound finances, while the Argentinean economy is emerging and is no stranger to recession, hyperinflation, currency devaluation and default. Look at their relative behaviour since the beginning of the year (this is in local currency terms, bear in mind the Argentinean peso is also down about 50% versus the USD YTD).

Source: Bloomberg, 28/12/2018 - 04/09/2019.

Recently, Argentina has again fallen into technical default, despite the biggest bailout package in the IMF’s history (US$57 billion). A weak economy and political instability are not luxuries that Argentina could afford. They contributed to weakening the peso materially and putting considerable pressure on the servicing of the mainly USD denominated debt.

And while Argentinean government debt has defaulted eight times, only two years ago investors were so optimistic that this time it would be different that they supported this 100 year government bond issue. This wonderfully illustrated both the degree of capital misallocation and the collective short-term memory of financial markets.

What about contagion risk to other emerging markets? The Argentinean economy and financial markets are small, though their major trading partner is Brazil, which was already looking somewhat fragile. More generally though, emerging markets are more concerned about slowing global growth, global trade wars and the strong US dollar.

With the Argentinean economic and financial market history in mind, perhaps recent events in Argentina are much less surprising than what has happened to the Austrian bond: significantly outperforming equities YTD. Much of this has to do with the material amount of bonds that are increasingly on a negative yield, and of course the very long duration. Stepping back, the relative performance of these two issues has been the story of the year: markets have bought safety and sold risk.

We haven’t owned either of these issues, both are too speculative for us. As always with bonds, it is a story of credit risk and interest rate (duration) risk. Argentina is now considered to be poor credit quality, Austria is perceived to be excellent credit quality and, for both, the material duration risk exaggerates the impact of the credit risk.

From our perspective we think it’s sensible to look beyond government bonds for safe haven assets. We currently have a material exposure to gold and some to silver, we have some defensive equity, some of which is denominated in safe haven currencies, such as the Japanese yen, and these complement our UK and US government bond exposures.

Anthony Rayner is manager of Miton’s multi asset fund range.

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