What is risky and what is safe? That has always been a crucial question for anyone working in the financial markets. Bankers provide their clients with an asset mix, tailored to suit the aging widow or the young entrepreneur.
But what if everything you know about risk was suddenly turned upside down? In the last two years, all the stuff we thought was really safe and dull turned out to be dangerous. And the things we thought were risky ended up being quite reliable.
In reality, investors need to reverse everything they thought they knew about risk. Assets such as property, the dollar and developed-country bonds are only for those who don’t mind losing their shirts. Small-time investors who depend on getting their money back should be buying into small companies, emerging markets and private-equity or hedge funds.
Risk has always been important in markets. Think of those know-your-client forms that banks get you to fill in. Describe yourself as risk-averse, and they will offer you a mix of government bonds, maybe some blue-chip equities and a lot of real estate in developed countries. Describe yourself as risk- friendly, and they will get out the brochure on that hedge fund that specializes in high-velocity Kazakh yak-hide trading.
Our ideas about risk determine how money flows around the world, and the price paid for it. The higher the risk, the greater the return you expect, and vice versa.
Everything We Knew
The global financial crisis of 2008 changed everything that we knew to be safe.
Were bank deposits a good option? Not if they were with an Icelandic bank, even if it was regulated in the U.K. or the Netherlands. Anyone with money in a major European or U.S. lender was only a bailout package away from losing the lot. That doesn’t sound very secure.
How about property? We might be used to the phrase “safe as houses,” but it doesn’t apply to homes as an asset class anymore. Take the British market. According to a recent report by accounting firm PricewaterhouseCoopers LLP, after adjusting for inflation there is a 70 percent chance house prices will be lower in 2015 than they were in 2007. It could be 2020 before they get back to their peak in real terms. In most major markets, property is overpriced and dependent on bank financing that has dried up. There is nothing safe about that.
Government bonds, anyone? If you held Greek debt, your portfolio wouldn’t have looked too healthy over the past year. If you bought U.K. or U.S. bonds, it might be looking a bit better. But you should probably be feeling nervous. The markets picked on Greece, and made an example of it, but its budget deficit wasn’t much bigger than that of the U.S. or Britain. At any moment, they might get mauled as badly as Greek bonds did earlier this year. Even if you stick with financially responsible countries such as Germany, they are still getting stuck with the bills of their neighbors in the euro area.
Likewise the dollar. The budget and trade shortfalls might create a crisis at any time. The Swiss franc? If Credit Suisse Group AG went bust, the whole country would be brought down, much like Iceland. No traditionally “safe” asset looks very solid right now.
The risky stuff looks safer. Not convinced?
Most emerging markets have much higher growth rates, healthier demographics and more buoyant tax revenue than their peers in the developed world. Their currencies, bonds and equity markets look more reliable than any in the U.S. or Europe.
Corporate bonds are a better bet than most government bonds. Would you rather have your money in Vodafone Group Plc, with millions of customers paying their mobile-phone bills every month? Or in U.K. government bonds, with a weak economy, a massive welfare bill and a budget deficit equal to more than 10 percent of gross domestic product?
Small companies are safer than blue chips. Just think of the problems that BP Plc has run into in the past few months. Giant enterprises can run into giant trouble. The smaller businesses can flourish under the radar.
Private-equity and hedge funds beat bank deposits. It was the banks that ran into trouble in the credit crunch, not the alternative-investment industry.
We don’t know precisely what will emerge as “safe” once the dust has settled on both the credit crunch and the sovereign-debt crisis. But emerging markets are safer than developed ones, equities beat property, and corporate bonds are preferable to government notes.
Sometime around 2015, don’t be surprised if bankers are advising widows and trust funds, which need to preserve capital above all else. They will be offered Turkish bonds, a hedge fund or two, and a portfolio of small emerging-market stocks. Real estate, Treasury bills, and dollar or euro blue-chips will only be for people who fancy a flutter -- and have already been warned they may lose everything.
(Matthew Lynn is a Bloomberg News columnist and the author of “Bust,” a forthcoming book on the Greek debt crisis. The opinions expressed are his own.)
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