“More great fortunes are made during bad times than good times.”
-- Rhett Butler in Gone with the Wind
This quote is in honor of Richard Jenrette, who passed away last week. He cited it in his memoir, The Contrarian Manager. Jenrette co-founded the legendary firm Donaldson, Lufkin, & Jenrette. Success on Wall Street is not rare; a great culture is. I had the good fortune to meet Jenrette, and he made a profound impression on me. The world has lost a great man.
Safe Haven Impostors?
Most commonly presumed “safe haven” investments do a poor job according to hedge fund manager Mark Spitznagel. He warns that many will fail to deliver the protection investors expect. Others will likely perform as expected, yet are an inefficient use of your capital.
Spitznagel is a pioneer of “tail hedging”, which he contends is the most efficient safe haven strategy for protecting your portfolio from sudden, severe market declines. (Anyone remember 2008?) His long-time collaborator, Nassim Taleb, is far better known as the author of NY Times best-seller The Black Swan.
Naturally, there’s been a growing interest in “safe havens”. Asset prices continue inflating to all-time highs. Whether it’s stocks, bonds, real estate, art, or you name it, everything looks expensive. Those of us old enough to have lived through past market euphorias have “seen this movie before”. We’re afraid of how it likely ends. But we’ve also seen enough movies to know that endings often have a twist. That’s why you shouldn’t walk out of a movie before it ends – even if you think you know what’s going to happen. Sometimes, even horror films surprise us with a happy ending.
The ambition of safe haven investing is to allocate a portion of your portfolio to investments that perform well when stocks and/or bonds do poorly.
But not all safe havens are created equal. There is an inherent trade-off between two things: 1) how much loss protection it provides in a crash and 2) how much capital you must allocate to it. Think of #2 as a “cost of capital”. The more capital required to allocate to a safe haven, the more it costs. The ideal safe haven provides substantial loss protection, isreliable, and uses up very little of your capital. In other words, you want a “big bang for your buck”. Further, you want a high degree of confidence that it will actually pay off if markets melt. (Remember from The Big Short how worried CDS investors were after the crash that failing brokers might fail to pay off on their successful bets?)
Most investments commonly thought of (or pitched) as “safe havens” fail in at least one of these respects. They’re either not reliable (counter party risk), don’t perform that well in a crash, and/or cost too much (or require too heavy an allocation in your portfolio).
For instance, "store-of-value" safe havens like US Treasuries or the Swiss franc help preserve capital in a market crash yet generate such meager returns that they fail to fully offset declining stock prices. Further, they require a substantial allocation in your portfolio, which “costs” a lot in the form of inferior long-term real returns to equities.
Other traditional safe havens, such as gold, macro hedge funds, or “long volatility” strategies may produce higher and more negatively correlated returns in a crash. Yet, even here, most fail to provide significant upside relative to the capital allocated to them.
Then there are safe haven impostors – investments that are commonly perceived (or pitched) as safe havens, yet fail to deliver a reliable and/or substantial return in a crash. This includes commodities, farmland, bonds, currencies, VIX futures, high-dividend stocks, value stocks, art, and most hedge funds. These range from “hopeful havens” (i.e.: low confidence level they’ll actually work sufficiently in a crash) to downright “unsafe havens” (i.e.: high dividend stocks). Granted, these may be diversifiers, or even attractive long-term investments. But Spitznagel contends they are likely to fail as true safe havens.
What, then, does Spitznagel recommend? For over a decade he has been making the case for a “tail-hedge” strategy as the optimal safe haven strategy. (This is the strategy that his firm, Universa, employs.) It seeks a far bigger “bang for the buck”. The ambition is to allow an investor to allocate a far lower percentage of their capital to the safe haven bucket and have a higher degree of confidence in the reliability of the safe haven to work when it is most needed. Fielder has conducted extensive due diligence on this strategy. It is not a “free lunch” – those do not exist. Nor is a tail hedge strategy appropriate for every investor. The following video is a good overview of Spitznagel's reasoning and some of the numbers behind it:
(Click image to watch the video)
For more details on safe haven investment strategies, please contact me. We’d be happy to share what we’ve learned and how we’re implementing these strategies in different ways for our clients.
Yours in the Field,
Frank Byrd, CFA
Disclaimer: While the information presented herein is believed to be accurate, Fielder Capital Group LLC (Fielder) makes no express warranty as to the completeness or accuracy, nor can it accept responsibility for errors appearing in the document. Fielder is under no obligation to notify you of any errors discovered later or of any subsequent changes in opinions. Nothing herein should be construed as a recommendation to buy or sell any of these securities. It should not be assumed that any of the securities, transactions, or holdings discussed will prove to be profitable in the future or that investment recommendations or decisions Fielder makes in the future will be profitable or will equal the investment performance of the securities discussed herein. Fielder or its employees may have an economic interest in securities mentioned herein.
This note is intended merely to educate readers on the concept of safe havens. Nothing herein should be construed as an endorsement of Universa or a recommendation for any of the funds that it manages. Universa's funds may not be suitable for you.