In previous surveys, managers had worried most about the impact of any policy error by the Federal Reserve or European Central Bank, but in September a net 34% of global managers cited North Korea as the biggest threat.
It seems fund managers are not the only ones worried. In the immediate aftermath of North Korea firing a missile over the bow of Japan, the price of gold spiked to a yearly high as investors rushed to buy up the so-called safe-haven asset.
But is buying gold really the best strategy when investors become nervous regarding markets and is now the time to be defensive?
James Calder, research director at City Asset Management, says: “If North Korea does press the button then all bets are off. It won’t be a UK issue; it will be a global issue. However, while it will be a huge tail risk event if it happens, the probability remains low and we have not been changing our portfolios on the basis of it.
“Gold is an easy story to sell but, for us, the approach is too simplistic. It is a blunt instrument, which is OK to have as part of your toolbox and at times it will work, but only in the very short term.
“However, we are not day traders and over the medium term I struggle to see a compelling argument for holding the asset class, even if you want to become more defensive.”
Glass half-full
Indeed, the prospect of a nuclear war with North Korea aside, Calder sees plenty of reasons for optimism from a global perspective.
“We remain in the most unloved bull market in history and these things don’t just die of old age,” he says.
“While the UK is going into a slowdown and looks quite gloomy, global economic data looks positive, with several economies in expansionary mode. In general, our attitude is one of being glass half-full, rather than half-empty.”
That said, Calder notes in the past 18 months he has been reducing equity risk within City Asset Management’s portfolios and buying into asset classes which he believes are less dependent on the direction of equity markets.
“Rather than buy gold we have taken a more sophisticated approach,” Calder says. “For example, we invested in alternatives for income, such as infrastructure, and added more global macro, market-neutral and long/short equity funds.
“This means we are not dependent on which way equity markets move. It’s all about getting pure alpha and, for me, investing in gold is a negative beta play. It’s a physical asset class that is a binary bet.”
Adrian Lowcock, investment director at Architas, describes gold as a Marmite investment among investors: they either love it or hate it. Describing it as a “volatile” asset class over the past two decades, he says it was shunned in favour of growth stocks as technology boomed in the 1990s.
“However, it recovered following the dotcom bubble and rallied strongly into the financial crisis,” he says. “This strong performance was used to highlight the fact it had completely decoupled with its traditional role as a store of value.”
Yet while both the bursting of the dotcom bubble and the financial crisis had an impact on the demand for gold, according to Lowcock, there were also some significant changes taking place, which meant that the asset class became readily accessible to nearly all investors.
“The development of ETFs and the ability to trade through the internet allowed the average investor to get a direct exposure to gold,” he says. “This made gold more tradable and therefore more susceptible to speculative investing.
“But while speculative investors can increase the short-term volatility of an asset, they don’t tend to have as much of an impact on the long term and don’t change the characteristics of the asset itself. Gold is still seen as a store of value and there is still healthy demand for it.”
One of the reasons behind this demand is the notion that gold is lowly correlated to the performance of equities. For example, Lowcock says that while markets saw a big sell in 2016 before recovering, gold had already started to perform in December.
“The correlation of gold with the FTSE 100 is low at around 0.16, even lower than that of gilts at 0.19,” he says. “Gold is also priced and traded in US dollars, which adds an element of support to its defensive characteristics as the dollar is also regarded as a safe haven in time of crisis.
“The recent devaluation of the pound is one of the reasons gold performed well for UK investors in 2016, and it performed strongly in the June of that year.”
Lowcock cautions that just because gold has a long history of protecting wealth over the longer term, and has proved to be a defensive asset class in times of stress, investors should not assume it is not possible to lose money in it.
“With the asset more tradable than ever, it is susceptible to short-term volatility and price swings,” he says.
Gilt dilemma
Like Calder, another manager not piling into the asset class is Justin Onuekwusi, lead manager of Legal & General Investment Management’s multi-index fund range. He thinks being too defensive right now may prove costly for investors.
“The global economy remains in a Goldilocks scenario, namely one of reasonable growth with limited inflationary pressures and a limited probability of recession,” he says.
“Over the medium term, despite current cyclical upward pressures, it is hard not to see structural headwinds to inflation, and with oil expected to remain in a trading range, the two most common triggers for a recession have decreased in likelihood.”
If he were to become more defensive, though, Onuekwusi also questions the logic of moving into gold.
“While we recognise the hedging qualities of gold, investors aiming to value gold as an asset class within the allocation of a multi-asset portfolio can find it difficult,” he says. “It does not generate any cashflows and its price is driven more by sentiment than fundamentals. Therefore, we would prefer gold equities over direct exposure.”
Onuekwusi says the traditional method of providing a hedge against falling risk assets was via fixed income assets, in particular government bonds. However, he says the level of yields in bond markets has left multi-asset investors with a “gilt dilemma”.
“With the unprecedented expansion in balance sheets of central banks since the financial crisis, there is a risk that gilts cannot provide the same protection in portfolios they once did.”
Instead, Onuekwusi believes investing in global government debt is a sensible diversifier away from gilts, and should still provide some protection should there be a sell-off in riskier assets. “Despite the paltry yields currently on offer, it is these government bonds that can provide true protection for multi-asset portfolios,” he says.
Falling short
Not everyone is a gold bear, although Chris Rush, senior analyst at Iboss, admits that for a long time the firm has been in that camp. He says Iboss has long been of the opinion that around a 2% holding in gold would do little to protect a portfolio from a catastrophic event, even if it were to outperform other asset classes considerably.
“We also argued that should a real doomsday scenario occur it wouldn’t really matter if you held a gold brick or a government bond, it’s unlikely to help you out when there’s fighting on the streets. AK47s and tinned food would be potentially the better defensive asset,” says Rush.
However, he says circumstances have changed and investors have changed with them, which explains why Iboss recently added a 1% holding across the Oeic range in the Old Mutual Gold and Silver Fund.
“We first looked at this fund approximately 12 months ago and by not holding it over the intervening period we have saved ourselves 6% of negative return and a whole heap of volatility,” says Rush.
“As an asset class, gold offers diversification but that is far from sufficient reason to invest in anything.”
Owing to the make-up of the fund, which is managed by Ned Neylor Layland, Rush says it is always likely to be more volatile than most other assets they hold. It is for this reason they are introducing the fund at 1% across the investment range, breaking with the traditional minimum of 2%.
“We may look to increase the holding in the future but that will depend on the economic backdrop, visibility of systemic risk and relative performance,” Rush says.
“We feel it is more prudent than ever to build in defensive and, where possible, non-correlated assets to all our investments. As ever, we try to avoid markets that are overpriced relative to history – and this is another step in the same direction.”
