In Search of Safe Assets

The risk-free rate is a common term in financial equations – it’s a part of everything from the Sharpe Ratio to the (in)famous Black-Scholes equation for pricing options. It’s simple in theory – an investor’s expected return on a risk-free investment, one that’s perfectly safe.

In theory. But where to get such “safe” assets in practice… and what does “safe” mean, exactly?

For practical purposes, short-term US Treasuries are generally considered “risk free,” although there is still obviously a small but non-zero chance that the government and economy of the United will disintegrate before maturity. Barring a total collapse, there’s still a chance for capital loss on US bonds if rates rise (making newly-issued bonds more valuable).

We’ve been anticipating just such a fall in bond prices eventually (and we’re far from the only ones). Indeed, the idea that US borrowing costs are going to skyrocket and bankrupt the country has been a popular refrain for the last few years, and is a driving force behind the anti-deficit chorus pushing for spending cuts. Yet despite all of the doomsaying, US interest rates have remained incredibly low. In other words, investors still see US treasuries as a relatively risk-free investment (which, in a sort of manifest destiny, makes it so). The Economist finance blog Free Exchange has an interesting take on this, arguing that this has been largely due to a shortage of safe assets:

…Why would there be a relative shortage of safe assets?

One reason is that people are more aware of downside risk than in the past, thanks to the collapse in middle class wealth and the massive increase in joblessness; there is more demand for safe assets. This is actually healthy and overdue. In fact, there is good reason to think that the process still has a long way to go. The safe asset shortage can also be attributed to the fact that many assets previously thought of as “safe” are no longer seen that way, whether they are Italian government bonds or subprime mortgage securities. Thus, the supply of safe assets declined even as the demand for them soared.

This coincided with some interesting thoughts on the big credit rating agencies from Barry Ritholtz addressing a question we’ve had for years: why does anybody pay attention to the ratings agencies? Well, the evidence suggests that, increasingly, people aren’t. Credit ratings are increasingly being ignored by investors, who have their own ideas about what’s safe and what isn’t. The big three are struggling to play catch-up to the decisions that the markets have already made about creditworthiness. And in large part, those decisions are negative for just about everything other than US treasuries.

What does all this mean? Well, in a world where mortgage-backed securities and Italian debt are no longer considered risk-free, US treasuries are one of the last few remaining “safe” assets around. With QE4 linked to actual measures of economic health (unemployment and inflation), we’ve effectively ruled out a rate hike from the Fed for the forseeable future. And with the creditworthiness of most of the rest of the world still in question, “bond vigilantes” have few alternatives to protect their capital.

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Those investors who are qualified eligible persons as that term is defined by CFTC regulation 4.7 and interested in investing in a program exempt from having to provide a disclosure document and considered by the regulations to be sophisticated enough to understand the risks and be able to interpret the accuracy and completeness of any performance information on their own.

RCM receives a portion of the commodity brokerage commissions you pay in connection with your futures trading and/or a portion of the interest income (if any) earned on an account's assets. The listed manager may also pay RCM a portion of the fees they receive from accounts introduced to them by RCM.

See the full terms of use and risk disclaimer here.

Disclaimer
The performance data displayed herein is compiled from various sources, including BarclayHedge, and reports directly from the advisors. These performance figures should not be relied on independent of the individual advisor's disclosure document, which has important information regarding the method of calculation used, whether or not the performance includes proprietary results, and other important footnotes on the advisor's track record.

Benchmark index performance is for the constituents of that index only, and does not represent the entire universe of possible investments within that asset class. And further, that there can be limitations and biases to indices such as survivorship, self reporting, and instant history.

Managed futures accounts can subject to substantial charges for management and advisory fees. The numbers within this website include all such fees, but it may be necessary for those accounts that are subject to these charges to make substantial trading profits in the future to avoid depletion or exhaustion of their assets.

Investors interested in investing with a managed futures program (excepting those programs which are offered exclusively to qualified eligible persons as that term is defined by CFTC regulation 4.7) will be required to receive and sign off on a disclosure document in compliance with certain CFT rules The disclosure documents contains a complete description of the principal risk factors and each fee to be charged to your account by the CTA, as well as the composite performance of accounts under the CTA's management over at least the most recent five years. Investor interested in investing in any of the programs on this website are urged to carefully read these disclosure documents, including, but not limited to the performance information, before investing in any such programs.

Those investors who are qualified eligible persons as that term is defined by CFTC regulation 4.7 and interested in investing in a program exempt from having to provide a disclosure document and considered by the regulations to be sophisticated enough to understand the risks and be able to interpret the accuracy and completeness of any performance information on their own.

RCM receives a portion of the commodity brokerage commissions you pay in connection with your futures trading and/or a portion of the interest income (if any) earned on an account's assets. The listed manager may also pay RCM a portion of the fees they receive from accounts introduced to them by RCM.

See the full terms of use and risk disclaimer here.