Suppose that you believe that a global market downturn is imminent. You might sell stocks and real estate, but where do you put that capital? While cash is an obvious choice, it doesn't offer any yield or upside potential, and there's a limit to how much cash you can hold in an insured account — especially for wealthy investors and institutions.
Let's take a closer look at how safe-haven asset classes provide investors with an alternative during uncertain times, some common examples of safe-haven assets, and whether cryptocurrencies fit the bill.
What Is a Safe-Haven Asset Class?
Safe-haven asset classes are investments that are expected to retain or increase in value during turbulent markets. By purchasing these assets, investors hope to minimize their losses in the event of a market downturn. They may also provide an opportunity to profit for investors that purchase them *before* a market downturn.
Most safe-haven asset classes are characterized by:
- Low Correction: The value of the asset has a low or inverse correlation with at-risk financial assets like stocks. In other words, their value either doesn't respond to or moves inversely with the value of stock indexes.
- Low Volatility: The asset has less volatility than at-risk financial assets like stocks. They don't move as high or as low and retain a more even value, as measured by their variance or beta coefficient.
Safe-haven asset classes during one period of market volatility may react differently during another time. For example, the Swiss franc was a safe-haven asset class during the European sovereign debt crisis, but after pegging its value to the euro, the currency lost its safe-haven status. Others, like gold, have always been an effective hedge against risk.
It's important to note that most investors only shift a portion of their assets into safe-haven asset classes during uncertain times. Rather than selling every stock they own, they shift a greater portion of their portfolio into defensive stocks or gold to hedge against the risk of decline. That way, they still benefit from diversification.
Popular Safe-Haven Asset Classes
There are many different types of safe-haven asset classes, ranging from government debt to precious metals, but gold is the most widely known. While gold provides no yield and costs money to store, it has the longest history of being a hedge against inflation around the world — governments even maintain gold reserves for these same reasons.
Bonds are another popular safe-haven asset class since they provide a stable store of value. For example, there's very little risk that the U.S. government would default on a bond, most bonds pay a positive yields (unlike gold), and Treasuries alone are a $14 trillion market, which means that it's large enough to support any investor looking to park capital.
The most popular types of safe-haven asset classes are:
- Bonds: U.S. Treasuries are often considered safe-haven asset class since it's a very deep market that's backed by one of the largest economies in the world.
- Precious Metals: Gold, silver, palladium and other precious metals are often considered safe-haven asset classes because of their scarcity and historical value.
- Currencies: The Swiss Franc and Japanese Yen are two currencies that are frequently considered safe-haven currencies because of their central banks.
- Stocks: Utilities and other defensive sectors are often considered safe-haven asset classes because they provide services that their customers need day-to-day.
Why Cryptocurrencies Make Sense
Cryptocurrencies share many similarities with precious metals. For example, many of them have a finite supply that limits inflation and there's a cost to creating new units of the currency (e.g. mining). Cryptocurrencies also provide pseudo-anonymity, relatively frictionless transactions and involve far less storage costs than physical gold.
Many investors have turned to cryptocurrencies as an attractive safe-haven asset class due to their low correlation with the S&P 500 index and other equities. While the correlation hasn't always been negative, it has rarely crossed above 0.15, which suggests that it rarely moves in tandem with stocks. These attributes make it similar to gold and some bonds.
Crypto v. S&P 500 Index Correlations - Source: CoinMetrics
The problem with cryptocurrencies is that they are volatile, which makes them less of a 'safe' investment. In fact, the standard deviation of daily returns tends to vary between two and eight percent, which is significantly higher than the S&P 500 index, and especially, fixed income investments. They may not be correlated, but they are still risky.
Investors looking to diversify their portfolio may be able to mitigate some of the volatility by including crypto as just one part of a larger portfolio while still benefiting from the low correlation with other asset classes. At the same time, traders that are bullish on crypto could purchase it as a safe-haven asset in its own right if they're fine with volatility.
The Bottom Line
Investors turn to safe-haven assets during uncertain times as a way to preserve capital. While bonds and gold are the two best-known safe-haven asset classes, cryptocurrencies have become a popular alternative safe-haven asset class given their pseudo anonymity, low-friction transactions and low storage costs compared to gold and other precious metals.
While cryptocurrencies can be exceptionally volatile, they could serve a valuable role in reducing systemic risk in a properly diversified portfolio. Anyone considering cryptocurrencies in their portfolio should consult with their financial advisor to discuss the best ways to do so while managing risk and reaching their financial goals.
If you're looking to incorporate crypto into your investment portfolio, ZenLedger can help ensure that your taxes are properly prepared to avoid any IRS trouble. Our platform automatically imports transactions across wallets and exchanges, computes capital gains and losses, and pre-fills popular IRS forms, like Form 1040 Schedule D and Form 8949.