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In Search of the Next "Safe Haven"
Is it Time to Put Your Money Under Your Mattress?
 By Jill Johnson, Senior Investment Officer
Russell Investment Group
Global Leaders in Multi-Manager Investing
March 25, 2003
This article has been provided by our parent company, and primarily deals with the US market.
In a world full of uncertainties, some investors are constantly seeking the next "sure" thing. Generally, this means equities when the economy is doing well and investor sentiment is positive. When equities begin to look too expensive, sentiment often switches to buying corporate bonds from the largest, most stable blue-chip companies. Finally, US Treasury bonds often look particularly enticing when the economic or political scene seems too unfriendly.
In today's environment, investors who seek safe havens are facing a dilemma. For the past couple of years, bonds have provided relative protection from the difficult equity markets, but conventional wisdom says bonds are looking expensive and, therefore, risky. Last year alone, they rose an unprecedented 10.3% according to the Lehman Brothers' Aggregate Bond Index. To boost the sluggish economy, the Fed has dropped interest rates to 40-year lows during the past two years causing fixed income prices to rise.
So, if equities and bonds are too risky right now; should investors put everything in cash?
Rather than eyeing your mattress as the next safe haven, Jeff Hussey, a Russell fixed income portfolio manager, cautions that things may not be as simple as they seem in the mathematically complex world of bonds. "While it is true that when interest rates drop, the price of bonds rises, interest rates have not dropped equally on all bonds. Short-term rates are low, but intermediate and long-term rates are just average based on a very long-term view," explains Hussey.
Hussey also points out that, since the financial markets are priced by supply and demand, when all investors are convinced of something, anything, sentiment is generally already priced into the market. This would apply to the current widespread perception that interest rates will rise.
So, cash still sounds like the answer, right?
Dennis Trittin, a Russell US equities portfolio manager, points out another consideration, "cash doesn't rally." And it will lose value by not keeping pace with inflation.
Also, timing is important. Because of the two-year bond-market rally, some ultra-cautious investors considered going to cash a year ago. Those who made the move gave up the previously mentioned 10.3% return of the Lehman Brothers' Aggregate Bond Index in 2002. Likewise, no one knows when the largely anticipated interest-rate rise may occur, or what bond returns will be in 2003.
It's also hard to predict exactly what effect this possible rate rise may have on diversified portfolios. For example, higher interest rates usually dampen equity prices since they result in higher borrowing costs. Bonds have historically been a better diversifier to equities than cash.
Remember, the bond markets are complicated and all bond rates do not rise and fall in tandem. While higher interest rates may reduce returns for some types of bonds, higher interest rates for corporate bonds could make them more attractive to investors. "Returns could be higher because spreads might tighten," Hussey said. This is when, for example, the price of corporate bonds in a diversified portfolio dips less than that of US Treasuries resulting in higher overall returns.
A recent paper written by Lehman Brothers brings up another point. Forty years is not long enough to be announcing "record" or "historic" levels for bonds and interest rates. Two centuries makes more sense1.
"Long-US rates have been (at current levels) and much lower (ones) for much of the past two centuries; the 1970s, 1980s, and 1990s were more the aberration," states the Lehman Brothers research. The paper concludes that "although the US (yield) curve likely will give up some ground this year, the upward rebound may be less than envisioned by bond pessimists."
More words of caution from one of Russell's seasoned investment veterans, chief investment strategist Ernie Ankrim: "We encourage investors not to design a portfolio that will be 'correct' only if things turn out much worse than expected. In this fear-rich environment people are more likely to be too conservative than too risky."
Stuffing your mattress with your life savings would be correct only under the most narrow, and negative, of circumstances. So, use your mattress for a good night's sleep and stick to the diversified investment approach that aligns your risk tolerance with your long-term goals. After all, moving to cash may present more risks than staying the course.
Copyright© Frank Russell Company 2003. All rights reserved. See Legal Information. Date of first use: 04/01/03.
This is a publication of our parent, Frank Russell Company. It should not be construed as investment, legal, or tax advice. The contents are intended for general information purposes only, and you are urged to consult your own investment, legal, or tax advisor concerning your own situation and any specific investment questions you may have. For further information about these contents, please contact Russell Investments Canada Limited.
Greater risk is inherent in portfolios that invest primarily in high-yield bonds.
Past performance is not indicative of future results.
Diversification does not assure a profit or guarantee against loss in declining markets.
1 Lehman Brothers Fixed Income Research, Daily-Global Relative Value, of March 14, 2003.
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