Updated: Jul 15, 2020
If you think of a ‘safe haven’ asset, private equity will probably not be the first thing that pops into your head.
But maybe it should be!
A possible recession, macro uncertainties, and more are causing investors to seek safe haven assets
Traditional safe haven assets are expensive and maybe not quite as ‘safe’
Private equity is a valid alternative safe haven asset
Even if a recession is not coming private equity offers a better risk return
Private equity is risky, so it’s critical to invest with the right managers and diversify
Trouble is coming
Recessions are hard to predict – if I could with any accuracy, I would probably not be writing a blog – but there are several economic indicators that give some warning.
Figure 1: Yield curve inversion is predicting a recession
Source: PE Compass, New York Fed data as of October 2019
Others don’t look much better. Employment figures in the U.S. have recently disappointed. Housing prices, where several markets have seen boom years, and consumer and producer indices, which have started to contract.
None of this of, course, predicts a recession. And there is plenty of writing on this as well. Here is an insightful piece from Goldman Sachs.
Nonetheless, when also considering: subpar or slowing growth; slow, low, or no inflation; low interest rates, geopolitical concerns; and jittery markets. And it’s little wonder that investors are positioning themselves for a downturn!
Safe haven assets in times of trouble
Investopedia defines 'safe haven' assets as ones that are expected to retain or increase in value during times of market turbulence.
Noting that safe haven assets change over time and depends on the specific market conditions, these would traditionally include:
Short duration government bonds, especially T-bills
Cash – typically CHF, USD, JPY, EUR
Defensive stocks – utilities, consumer staples, parts of health care, and energy
But safe havens are risky!
However, the current market environment is not quite as favorable to the traditional safe have assets.
Gold, at USD 1,500-an-ounce, is at a 6 year high
It yields nothing, generates no cash flow. And its is probably most useful as an inflation hedge. Gold might be a bit late to buy – at least if you don’t believe in inflation rebounding – which right now would be quite a contrarian stance.
Fixed income – how much will you pay for ‘safety’?
Bonds, though safe, are providing little to no yield. The dark blue bars in Figure 2. are sub-zero yield, corresponding to the much talked about USD 16-17 trillion of negatively yielding debt.
Even if headline grabbing, the problem for investors go well beyond this.
Figure 2: Continued and increasing lower bond yield
Source: FT 2019
‘Safe’ but value destroying
The following example from Peter Spiller of CG Asset Management, as quoted in the FT, perfectly illustrates this problem.
“If you want to have an inflation adjusted GPB 1 for retirement in 2068, 49 years away. This could be achieved by investing in a gilt that matures then. Right now, you would need to put in GBP 2.60 for every GBP 1 you get. Why? Because that is the compounding effect of investing for 49 years at the negative 2.05% yield that the bond offers investors today.”
Unless you want to move out on the risk curve, which somewhat negates the ‘safety’, very low and negative rates are a challenge both for asset managers, looking for a safe haven and some yield, and for private investors saving for retirement.
Cash – a liability that you can be charged for
According to the FT, UniCredit looks set to join UBS, Credit Suisse, and two Danish banks in charging clients for deposits above a certain threshold.
Should this become the ‘norm’, investors will have to get used to pay for the privilege of having savings in cash – unless, that is, they feel comfortable keeping it in the mattress at home.
Stocks are at their second most expensive period in 150 years
Even with new interest rate cuts and further quantitative easing it’s questionable how much more stocks can increase on the same fundamentals.
By most valuation measures equities are generally considered elevated. And, more defensive or not, as are utilities, consumer staples, health care, and energy, which are all also still correlated with the broader market.
What do you do as an investor?
Many professional asset managers must be fully invested at all times.
Consequently, they have loosened their definition of risk and are looking to things like: corporate debt; collateralized securities; and stocks. Assets that offer some shelter, a bit of extra yield – even if relatively riskier.
For investors with some flexibility private equity is an alternative safe haven
As discussed in this post, private equity is relatively more stable in a downturn, it rebounds quicker, and it has historically outperformed all other asset classes. And, because of the ‘Illiquidity Advantage’, investors avoid market timing issues of selling and buying too late.
PE is professionally managed throughout a downturn. And though the vintages leading up to a downturn may be more challenged they have historically come out well, while vintages invested just after, have a significant advantage in buying assets at improved valuations.
Widening the definition of 'safe haven' only a little, for investors that can tolerate the illiquidity and who have more flexibility in their asset allocation private equity is a very good alternative safe haven.
The rumor of a recession is exaggerated
Maybe it is and maybe a recession is not imminent. But most traditional assets are at this point in the cycle expensive and look like a much poorer risk-return than PE.
Consequently, for those who can, a move into PE might in any case be a better option.
But investing in private equity is challenging and it’s risky!
The challenge for investors is how to invest in private equity, getting the money put to work, and to work with the ‘right’ managers. Not all of these are 1st or even 2nd quartile and all are prone to irrational exuberance and face pressure to put capital to work.
Additionally, compared with government bonds not least US Treasuries, which are virtually risk free, private equity is a risky asset class.
But, if done right, while private equity investments themselves are risky, investing in private equity is not necessarily so!
More on these very important points in future posts.
Sources: Investopedia. October 2019; FT, October 2019; New York Fed, October 2019; Goldman Sachs, July 2019; Bloomberg, June 2019.