Investors, Worried About Debt Talks, Look for Havens

Many investors are worried that lawmakers will not come to an agreement about the debt ceiling in time and many of these investors are looking towards safe haven assets to put their money. Also, many are worried about the possible downgrade of US government debt.

By ERIC DASH and NELSON D. SCHWARTZ
Published: July 27, 2011
NY TIMES

Think of it as the flight to safety every investor would like a seat on. The only problem? Nothing is taking off.

Investors are seeking alternatives to United States Treasury bonds as worries escalate that lawmakers will fail to reach an agreement to rein in the deficit and raise the federal debt limit in the coming days. Some have shifted funds into corporate bonds, others are forgetting about yields entirely and parking their money in cash, and more are looking to those classic safe havens of yore, gold and the Swiss franc.

Investors are getting leery of stocks, however. Shares dropped on Wednesday amid growing worry about the deadlock in Washington and the economic outlook for the country. The broader market as measured by the Standard & Poor’s 500-stock index closed 2.03 percent lower, or 27.05 points, to 1,304.89. The Dow Jones industrial average was down 198.75 points, or 1.59 percent, to 12,302.55, its fourth straight decline.

Still, Treasury bond prices remained firm on Wednesday, with the benchmark 10-year bond rising two basis points to 2.98 percent. That shows demand is still healthy for the roughly $10 trillion of United States government debt circulating in the global financial system.

Investors are concerned that a downgrade of United States government debt by the rating agencies, or even the more remote possibility of a default, would erode the value of Treasury securities, which have long been considered virtually risk-free. The trouble is that in the end, safety is hard to find.

“Where are you going to go?” asked Carl Kaufman, who helps manage just under $2 billion at the Osterweis Strategic Income fund in San Francisco. Mr. Kaufman said he was loading up on high-yield bonds, like those issued by HCA, the hospital operator, and Dollar General, the retailer.

Other institutional investors are looking to faster-growing emerging markets.

Daniel Arbess, manager of the $3 billion Xerion fund at Perella Weinberg Partners in New York, is investing in companies that are benefiting from strong growth overseas, especially in countries like China and other Asian markets. Another strategy he favors is investing in natural resources and precious metals like gold that will preserve their worth even if paper currencies decline in value.

“These are our safe havens, not U.S. Treasuries,” he said. “You’ve got to hold your positions with conviction and concentrate on the fixed points on the horizon.”

Gold, already trading near record levels, dipped slightly Wednesday to close at $1,615 but is still up about 40 percent from a year ago. The Swiss franc, another classic refuge for safety-conscious investors, has jumped nearly 17 percent this year versus the United States dollar.

Other traditional havens, including stock and currency markets in Japan and Europe that might have been tempting in the past, are hardly appealing today, given the slow growth and mushrooming debt problems in those areas.

“Safety is a relative concept,” said Tobias Levkovich, chief equity strategist at Citigroup. “There have to be alternatives and the alternatives aren’t that wonderful.”

Corporations are also striking a defensive posture, stockpiling cash at record levels. And as the deadline for Washington to reach an agreement on raising the debt ceiling nears, many could start taking action, according to a survey this month of 305 large corporations by the Association of Financial Professionals.

Nearly one-quarter of the companies said they would sell some or all of their holdings of Treasury securities, while another 28 percent said they would not add Treasuries to their portfolios. A little fewer than half of the companies said they would not make any significant changes to their positions.

Even though default on government debt remains a remote possibility, some companies are already trying to get out in front of the market jitters. Capital One Financial, for example, moved up a $5 billion sale of billions in stock and bonds to avoid possible turbulence ahead of the Aug. 2 deadline the Treasury had set for lawmakers to raise the $14.3 trillion debt ceiling.

Money market funds, which traditionally have big holdings of short-term Treasury bills, are increasing their cash positions in anticipation of possible investor redemptions, said Joseph Abate, money market strategist at Barclays Capital. Government-only money funds are now holding about 70 percent of their assets in securities that mature in less than a week, up from nearly 50 percent three months ago.

The funds are shifting more of their assets into securities with a duration of one day, rather than run the risk of holding positions for a week or longer. They are also steering clear of government notes that are due in the first two weeks of August, fearful that a breakdown in the debt talks could force the government to miss a payment.

“The anxiety level around potential money fund redemptions is certainly higher than it’s been,” Mr. Abate said Wednesday.

Fears of a potential government default are showing up in the derivatives market, too.

For instance, there are 4.9 billion euros worth of derivatives known as credit-default swaps, which insure against a default of government debt and will most likely pay out if the nation does not make its bond payments. That is 1 billion euros higher than in May, according to the Markit Group, a financial data firm based in London. As the summer has progressed, the cost of buying that sort of insurance, which is essentially a bet that the United States government will default on its debt, has risen to 84,000 euros a year ($121,450) to insure Treasuries valued at 10 million euros, up from 35,000 euros ($50,600) in June.

Along with credit-default swaps, big investors and corporations are also eyeing so-called political risk insurance, which pays out in a government default.

In the past, customers largely inquired about coverage for developing countries, like Nigeria or Kazakhstan. Two years ago, they called about Greece, Portugal, and Spain.

But in the last few months, some foreign investors who rely on the government’s clean-energy subsidies to profitably develop wind and solar farms have asked the insurance giant Marsh & McLennan about political risk coverage on payments made by the United States.

“Out of the blue, this has come to my desk,” said Stephen Kay, senior vice president for the political risk division of Marsh.

Retail investors are largely staying on the sidelines, at least for now. Some, according to interviews with brokers and asset managers, are moving into six-month and one-year certificates of deposit.

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