The coronavirus has severely disrupted our lives and our economies. Despite massive interventions by central banks and governments, markets are in turmoil. There are many indications, that the current crisis will be worse than the Great Financial Crisis 2007-09 and might even match or surpass the Great Depression of the 1930s.
It is fully understandable, that many people currently focus on their health and their job prospects. Both are undoubtedly important, but they should not consume all of your time. If you have accumulated at least some wealth over the years, it is equally important to review your asset portfolio. In case you hold the wrong investments, you stand to lose part or most of your assets. But if you invest wisely, the returns can be life-changing.
The current crisis is most challenging even for seasoned investment professionals. Universa Tail Hedge Fund, that specializes in risk mitigation and is advised by renowned risk specialist Nassim Taleb, managed to achieve a stunning 4,144% return in the first quarter of 2010. Andurand’s Commodities Discretionary Enhanced Fund soared 122% in the same period, with a bet on crushing oil prices. Others were not so fortunate. Bridgewater Associates, the biggest hedge fund firm in the world, saw its main fund lose about 23%. The Alberta Investment Management Corporation (AIMCo), which manages nearly USD 125 billion for pension funds, suffered a USD 3 billion trading loss. But this was nothing compared to Norway’s Sovereign Wealth Fund, whose assets declined by a whopping USD 113 billion.
If we had free markets without excessive central bank and government intervention, we would certainly enter a deep recession and prices of stocks and bonds would plunge by half or more. But free markets are dead. Instead a small group of politicians and unelected officials try to control financial markets and the real economy.
Central bankers have already created trillions of new money ex nihilo. The U.S. FED alone increased its balance sheet by USD 2.5 trillion in the last 2 months, with more to come. The European Central Bank (ECB) and the Bank of England (BOJ) are just getting started. All are buying large amounts of government debt and also corporate bonds down to ‘junk’ level. Their aim is to avert a collapse in bond prices and keep interest rates near their target levels, which are close to zero or even below.
In the USA, the Corona Aid, Relief and Economic Security (CARES) Act amounting to USD 2 trillion (= 9.4% of GDP) has been approved. The EU is moving towards spending at least EUR 1 trillion (> 7% of GDP), while Germany alone has already passed a “Rettungsschirm” amounting to EUR 750 billion (= 21.8% of GDP). Other Western countries have also embarked on large stimulus programs and most programs will probably be extended in the next few months.
As detailed in our last blog, authorities will most likely not be able to avert a recession. But their actions will be a main determinant of future economic growth, inflation and asset prices. The more public money is created ex nihilo and inserted into the economy, the more markets will deviate from their natural development path in a competitive environment. But state intervention has its limits. Businesses, financial institutions, and individuals are also important players and together they have the power, to offset or even reverse government initiatives.
Among academics, analysts and businessmen there are heated discussions about the direction of the world economy. Forecasts range from a V-shaped recovery to a Greater Depression, from deep deflation to hyperinflation, and from booms to busts in asset prices. Countries will not all be affected in the same way. Some might only experience a minor recession, while others could face a complete breakdown of the society. Performance between industry sectors and even within the same sector will also vary to a large extent.
It is in times of crisis that old fortunes are lost and new fortunes are built. Staying on the sidelines is not an option. Instead every individual should allocate enough time, to review all assets and make far-reaching changes if necessary. Investments that have performed great over the last 5-10 years, might become losers and the other way around. And it might make sense to invest in some assets, that were previously ignored.
With the current uncertainty it is more important than ever for investors, to build a diversified portfolio that can perform well in different scenarios. Most people only think about asset diversification, but in the current crisis, diversification among jurisdictions and custodians is equally important.
A well-diversified portfolio is composed of various assets with low or even negative correlation. This means, that not all assets go up or down at the same time. Instead some assets might go up, while some stagnate, and the rest goes down. It is possible to achieve a better result by hedging the risk of each asset or asset group with options, futures or other financial instruments. But this is only a choice for true professionals with lots of experience (and even they get burned as shown above). Therefore, the average investor should aim to spread risk among various asset classes, and within each asset class among various individual titles.
Do you think that a portfolio invested 25% in stocks, 25% in bonds, 25% in an insurance policy, and 25% in cash is diversified? Most people would probably agree, we don’t. Normal life insurance policies, bonds and cash are all denominated in fiat currencies, be it USD, EUR, GBP, CAD or AUD. If there is high inflation, they will rapidly lose most of their value. As prices of stocks have gone up considerably over the last decade, fueled by artificially low interest rates and massive money printing, they are also not immune to changes in the value of national currencies. Despite being invested in various asset classes, the portfolio is heavily dependent on the performance of fiat currencies. If they fail, the portfolio fails.
In normal times, fiat currency risk would not be an issue. But we are not living in normal times. Governments and central banks have already made it clear, that they aim for inflation. Originally the target was 2%, but recent statements indicate, that authorities are willing to accept higher inflation. This comes hardly as a surprise. If they ever want to get rid of record debt levels, which currently stand at over 300% of world GDP, they need to inflate debt away. A truly diversified portfolio must include assets with low or no correlation with fiat currencies. And the main candidates for this are (physical) gold and Bitcoin.
Regular readers are familiar with our crisis portfolio, which has performed very well in recent months. In our next blog we will provide an update, to incorporate the latest developments.
Many people have all their assets in their home country. Even if they have bought foreign stocks and bonds, those are usually kept with a local bank or brokerage firm. This is certainly convenient, but also involves a lot of risks.
Being heavily exposed to a single jurisdiction can have devastating consequences. Most Western governments are heavily indebted, and the debt pile is growing to soar in the near future. It is just a matter of time, until governments start raising taxes, especially on real estate, that by definition can’t run away. But they won’t stop there. By promoting zero or negative interest rates, governments have already stolen billions from savers. They will have no scruple to enact measures to expropriate additional assets, either covertly or openly.
If you still have enough funds, don’t count on being able to spend them freely. To prevent bank runs and capital flight, governments have already started to restrict the free use of money. Larger cash deposits or withdrawals usually require a lot of paperwork or are even illegal. More restrictions are being prepared. Greece, a member of the EU and the Eurozone, has shown the way. To deal with the economic crisis of 2015, the Greek government decided to limit weekly ATM cash withdrawals to 420 EUR, severely restrict credit/debit card use abroad and enact other capital controls. It can happen tomorrow in our home country.
The crisis will not equally affect countries, and governments will react differently to the challenge. If you live in an allegedly stable jurisdiction in Europe or North America, you might find out very soon, that your economic freedom is being suppressed and your personal wealth is taken away from you. Holding some of your assets in other jurisdictions with a strong track record in protecting private property, will help you to preserve your wealth. Storing assets away from home might also facilitate a move abroad, if the situation in your home country becomes intolerable.
To learn more about why international diversification is important, read our blog A Live-Beyond-Borders mindset is crucial for everyone A Live-Beyond-Borders mindset is crucial for everyone.
Diversification among custodians
Banks and financial advisors urge you, to invest all of your money with them, to save fees and get a better service. That might or might not be the case, but we prefer to keep our assets with various custodians to reduce counterparty risk.
Many people still think, that banks are safe and that in the worst case, they can rely on a government-backed deposit protection theme. This is wishful thinking, especially in Europe where many banks are already on the brink of insolvency. With so-called “bail-ins”, which are already statutory in the U.S. and Europe, insolvent banks can use the money of unsecured creditors (such as savers) to restructure their capital to stay afloat. If you think this won’t happen in the Western World, just look at Cyprus, a member of the EU and the Eurozone. As part of a 10 billion bailout by the European Central Bank (ECB) and the International Monetary Fund (IMF), Cyprus agreed in 2013 to accept a bail-in at two of its insolvent banks, resulting in substantial losses for deposits above 100,000 EUR. If the current crisis deepens, such ‘haircuts’ will start at much lower levels and government deposit insurance schemes will not have enough money, to comply with their “guarantees”.
Insurance companies, brokerage firms and financial advisors are also not immune to bankruptcy. The longer the current crisis lasts and the deeper it gets, the more custodians are at risk of suspending services for a several weeks or going out of business altogether. Eventually you should get some of your money back, but this might take months or even years. In the meantime, you would have to live without it, which might prove disastrous, if you lose your job or need funds for other purposes.
At a time of declining business ethics and loose oversight, there is growing custody risk due to fraud. You might remember the case of Bernard L. Madoff Investment Securities LLC, that ran a Ponzi scheme costing its 4,800 clients about USD 65 billion. There are plenty of similar examples all over the world. Once the current crisis progresses, more cases of deception and gross negligence will be exposed. Be aware that despite monthly account statements issued by your bank or financial advisor, you can’t be 100% sure that the securities listed there were really bought for you, and that they haven’t been sold or “lent” in the meantime.
Considering the high risk of keeping all or most of your assets with one custodian, it is always recommendable to diversify among several custodians. This applies even more in the current crisis. Using at least two banks and two brokerage firms will certainly increase fees and personal workload, but this is more than offset by the reduced risk. Additional custodians in another jurisdiction should be added, as shown above. The same applies for other assets. To store all your gold and silver in just one vault, or all your Bitcoin in a single wallet, might have disastrous consequences.
The extent of the current crisis makes an in-depth review of your portfolio mandatory, to avoid very bad surprises in the future. If you are unclear, please contact us.
Disclaimer: The above is for informational purposes only. It is not an offer or advice to buy or sell any products or services. LBB and its owner do not provide investment, tax, legal, or accounting advice. Neither the company nor the author is responsible, directly or indirectly, for any damage or loss caused or alleged to be caused by or in connection with the use of or reliance on any content, goods or services mentioned in this article.
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