Gold strengthened by increased appetite for less liquid investments

Gold strengthened by increased appetite for less liquid investments!

Global portfolio composition continues to shift with larger allocations to alternatives. Many of these alternative investments have previously helped portfolio performance but are less liquid than traditional investments. The hunt for yield in a low-rate environment has also encouraged riskier fixed income investments. Increased alternative and lower quality fixed income exposure could result in a more volatile and less liquid portfolio overall. The shift to risker and less liquid assets strengthens the case for an allocation to gold, given its unique combination as a highly liquid diversifier, that can reduce portfolio volatility.

Investors are shifting more assets to fewer liquid alternatives. Portfolio composition has changed in response to the low-rate environment. Investors have moved further out on the credit curve, building high yield exposure and long-term Treasury positions in their search for yield and, although fixed income allocations remain significant, they are declining.
Data from Greenwich Coalition and Mercer as well as anecdotal evidence suggest that, along with this reduction in fixed income, investments in alternatives including private markets, real assets and infrastructure, have been growing. In fact, results from a recent market survey conducted in partnership with the Greenwich Coalition suggest that investors are targeting a third of their portfolio in alternatives and other assets over the coming 3 years.

Many of these alternative investments have helped portfolio performance historically, but they are often considerably less liquid. This, combined with the shift away from high-quality fixed income assets, increases portfolio volatility and duration risk, and decreases the liquidity profile of the overall portfolio, a key consideration amidst a high inflation environment.

Advantages and disadvantages of less liquid assets: Private markets are usually longer-term strategies that offer potential upside but carry illiquidity premiums. These assets are not marked-to-market (MTM) as frequently as: exchange-listed securities which, consequently, may understate their true volatility and rely on model-based valuation. In normal market conditions, this may not be an issue. But during risk-off environments it creates significant portfolio dislocations.

For example, following the Global Financial Crisis (GFC), institutional investors often asked hedge fund and private equity managers about the time it takes you to exit all their positions. Their concerns usually centred around counterparty risk and the ability to quickly exit illiquid positions when they needed to source capital. This remains a concern today: 42% of investors surveyed by Greenwich ranked liquidity concerns as one of their top three drivers of long-term allocation decisions.

Liquidity comes further to the forefront as investors explore more volatile assets like cryptocurrencies or non-fungible tokens (NFTs). It may also be relevant for farmland and collectibles, which can take a significant amount of time to buy or sell with varying degrees of bid/ask spreads. Gold may help to address this concern.

Improve your liquidity profile with a gold allocation: Gold can provide the capital and liquidity needed during a market selloff to counterbalance the effect of portfolios with larger exposures to less liquid assets. Gold trades between more than US$100bn per day in total, of which approximately US$60bn are traded in listed exchanges, whether in the form of spot contracts, gold futures or gold- backed ETFs. Gold tends to buffer portfolio drawdowns and is often one of the first assets sourced by investors to increase portfolio capital or, sometimes, to buy distressed securities. A common question we often get in the early phase of a sharp equity market sell-off is “why isn’t gold higher?”. In such situations, investors sometimes sell some of their gold position, because of its strong liquidity. However, the gold price historically bounces back quickly, improving the performance of the portfolio.

A prime example of this is the COVID-19 selloff of March 2020. During the market crash, gold sold off 12% (peak to trough) over seven trading days,6 yet recovered to finish the month flat.7 Meanwhile, the S&P 500 finished the month down 13%, global hedge funds lost 6%, and listed private equity lost 29%.8 In this instance, gold would have decreased overall portfolio volatility. Additionally, using gold to build positions in some of the distressed assets would have meaningfully increased 2020 returns; many assets finished the year significantly higher, while gold finished the year up 25% on its own.