Classification Of Assets
Could the classification of assets create a false sense of security and contribute to huge losses?
When faced with complex challenges, human intelligence tends to compartmentalize everything into systems, categories and groups.
Compartmentalizing things into systems has helped me to rebuild engines and diagnose engine problems
but it has made me overconfident in making loss making investments.
So to an untrained eye when the hood of an engine is lifted the viewer sees a tangle of electric wires, rubber hoses, pipes, rails and odd-shaped metal parts with some solid and other hollow.
But to a mechanic or a mechanical engineer, or even a hobby mechanic, they see a harmonious integration of systems coming together.
The brain starts to compartmentalize everything; that belongs to the cooling system, braking system, ignition system, exhaust system etc.
Similarly, an investor is taught to put assets in classes based on the assets’ level of risk to capital, capital growth and the income potential of the asset.
So a few examples of haven assets include precious metals, treasuries and other top credit-rated bonds or sovereign debt. Safe haven currencies include US dollars, USD, Swiss franc, CHF and the Japanese Yen.
Going up the risk scale, stocks, and there is even risk scalability in stocks.
Beta measures the responsiveness of a stock’s price to changes in the overall stock market.
A beta value that is less than 1.0 means that the security is theoretically less volatile than the market
The theory goes that including this stock in a portfolio makes it less risky than the same portfolio without the stock. For example, utility stocks often have low betas because they tend to move more slowly than market averages.
But the 2023 financial crisis bank runs highlight the false sense of security classifying assets into risk and safe-haven assets.
In a piece entitled, Lesser Risk Asset, dated February 2020 I wrote; “Finding the lesser risk asset in this frothy financial landscape would be challenging under normal circumstances, but these times are anything but normal.
A decade of emergency monetary policy, which entailed a head-spinning cocktail of negative, or near-zero interest rate policy and an unprecedented amount of liquidity pumped into the financial market through a program known as quantitative easing (QE) has created the bubble of bubbles, everything bubble.”
“Bonds, typically the lesser risk asset, are frothy too. With historic low cash deposit interest rates and massive central bank buying of bonds which have driven bond prices to sky high and their corresponding yields lower, even conservative investors are swimming in the deep end desperate for yields,” I added
The above analysis was the seed of the current 2023 systemic banking crisis
So here is the takeaway of the classification of assets piece; there is no such thing as a safe-haven asset. An asset has a price and if you overpay for that asset, whether it is classified as a risk or safe haven asset, a low beta stock you will lose money. The historic price of an asset would better guide investors on how to allocate funds.