The Search for Safety

What is a safe asset?

For many, safety means credit risk, full stop. Johnson & Johnson bonds are less risky than Ford bonds—the company has less leverage, stronger cashflow, and more steady revenue growth. But safety is more than just having a AAA rating. In August the US was downgraded from AAA to AA by S&P and interest rates still fell sharply. Clearly, the market was looking at something other than credit risk.

For many people, liquidity risk is real as well. In that regard, nothing can rival the US Treasury market. There are over $8 trillion in bonds in circulation, and billions outstanding in any single issue. The bonds are used to collateralize loans, other bonds, and derivative contracts.

By contrast, the most creditworthy nation in the world currently is Norway. They have a modest operating surplus in their government account, but the nation’s tremendous oil wealth is funding a long-term sovereign wealth fund that is professionally managed and that is growing steadily. To many, Norway is the epitome of sound fiscal management.

But there’s a problem in paradise. If people want to use Norwegian bonds as collateral, it’s hard to find them. And if they do find them, and need to sell them, there aren’t a lot of buyers. The market for Norwegian debt is thin: a small change in supply or demand can move the market a lot. By contrast, you could buy billions of dollars of US Treasuries and barely make a ripple in rates.

Safety isn’t just the assurance of getting your money back. It’s getting your money back when you want it. Smaller bond markets simply can’t do this. For that you need liquidity. And that makes US Treasuries the safest asset in the world. Let’s hope we can remain so.

By |2012-01-10T10:39:46+00:00January 10th, 2012|Global Market Update|0 Comments

About the Author:

Mr. Tengdin is the Chief Investment Officer at Charter Trust Company and author of “The Global Market Update”. The audio version of each post can be heard on radio stations throughout New England every weekday. Mr. Tengdin graduated from Dartmouth College, Magna Cum Laude. He received his Master of Arts from Trinity Divinity School, Magna Cum Laude and received his Chartered Financial Analyst (CFA) designation in 1992. Mr. Tengdin has been managing investment portfolios for over 30 years, working for Bank of Boston, State Street Global Advisors, Citibank – Tunisia, and Banknorth Group. Throughout his career, Mr. Tengdin has emphasized helping clients manage their financial risks in difficult environments where they can profit from investing in diverse assets in diverse settings. - Leave a comment if you have any questions—I read them all! - And Follow me on Twitter @GlobalMarketUpd

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