Is It Time to Buy "Safe" Assets?

No matter how aggressive an investor you are, at some point, you're going to want to invest in something safe. The big question, though, is whether there'll be any truly safe assets left when you need them.

The International Monetary Fund released figures yesterday that define a major threat to those trying to invest conservatively. According to the IMF, the weakening financial health of various sovereign governments around the world could shrink the available pool of assets it deems safe by a sixth by 2016. The IMF sees the potential impact of a safe-asset shortage as creating volatility in financial markets and impeding the free flow of capital around the world and within national economies.

As compelling as the IMF's argument is, one interesting element of it is how the IMF defines safe assets. The definition focuses on two areas: debt securities from both governments and the private sector, and gold. With gold representing $8.4 trillion or about 11% of the total, the vast bulk of the safe-asset pool -- about $66 trillion -- comes in the form of bonds.

If you're pickier about what constitutes safety than the IMF is, then you have an even narrower set of securities to choose from. Government bonds that receive AAA or AA ratings make up just half of the overall debt pool, at $33.2 trillion. Yet the IMF includes a bunch of other investments that certainly aren't risk-free, including everything from investment-grade corporate debt to mortgage-backed securities.

We've actually already seen plenty of disruptive activity in these safe-asset markets. The rise in gold prices over the past decade has surprised many analysts in its magnitude. But as big emerging markets like China and Russia have become frustrated with holding foreign reserves in currencies that lose their value, the appeal of gold has risen dramatically, pushing prices up. In addition, the convenience that bullion funds (NYS: SLV) and (ASE: CEF) have given those who want to invest in precious metals has turned those funds into economic forces in their own right.

Similar demand shifts have occurred in bonds. For instance, mortgage REITsAnnaly Capital (NYS: NLY) and American Capital Agency (NAS: AGNC) have snatched up an increasingly large amount of U.S. mortgage-backed securities in their quest to gain leverage and provide outsized returns based on the current shape of the yield curve. But with these entities using "safe" assets for decidedly unsafe leveraged purposes, the supply of remaining asset-backed securities is correspondingly smaller. If credit downgrades cause remaining issues to lose their safe status, then those who have to have high-quality assets could find themselves facing an insurmountable problem.

Of course, there is some hope that an economic revival could boost safe-asset supply somewhat. For instance, Ford (NYS: F) has had junk bond status for years, but the company has worked hard to try to regain an investment-grade bond rating. If Ford eventually gets that expected upgrade, it won't just mean lower borrowing costs for the company -- it'll also bring a new supply of investment-grade debt back to the market.

Perhaps worst of all, any shortage of investment opportunities that are perceived as safe could actually cause the crisis of confidence that would in turn endanger more national economies, leading to credit downgrades and a further contraction in available safe assets. That's a vicious circle that no one wants to see start spinning.

Nearly everyone needs at least some safe investments in their portfolios. The need for liquidity and preservation of capital drives allocations to safe assets and explains why bonds have been more popular than ever despite their low interest rates. But with prices already at elevated levels, loading up on safe assets now in the hopes of cashing in on a future shortage could well do you more harm than good in the long run.

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At the time thisarticle was published Fool contributor Dan Caplinger thinks safety is overrated. He doesn't own shares of the companies mentioned in this article. Motley Fool newsletter services have recommended buying shares of Ford and Annaly Capital, as well as creating a synthetic long position in Ford. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Fool's disclosure policy keeps you safe.

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