Investing: Are 'Safe Havens' Still Safe?

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In his view, the U.S. has gone from being the puppet master to the puppet, afraid of the consequences for the dollar were China to de-peg the value of its currency from the greenback and allow it to float.

Doubts About U.S. Financial Superpower Status

Brett Hellerman, chief executive of Wood Creek Capital Management, a hybrid hedge and private equity fund, sees the financial crisis and the call for such a huge bailout as just the latest in a series of misguided policy decisions over the past eight years that have severely eroded confidence in the U.S. "The price of the U.S. is going down. If we were a stock, we'd be for sale," he says. "I think the dollar is going to come under increasing attack here."

That kind of apocalyptic thinking is by no means confined to people on the margins. On Sept. 25, Germany's Finance Minister, Peer Steinbruck, predicted that as a result of the financial crisis, the U.S. will cede its role as a superpower of the world financial system to better-capitalized centers that are emerging in Asia and Europe, according to the Financial Times. That doesn't mean the dollar will lose its reserve currency status, but rather that it will become a more relative store of value, Steinbruck added.

Many investment professionals disagree, however. William Bellamy, director of fixed income portfolios at Thompson, Siegel & Walmsley in Richmond, Va., says he thinks the issuance of additional Treasury bills to pay for the bailout will have minimal impact on investor confidence in U.S. bonds as a safe haven. "Issuance will go up to fund the bailout but it will be over time. And if it corrects the underlying credit markets and unfreezes them, I don't think much concern at all should be put on the additional issuance," he says. "The U.S. is still the safest place in the world to invest and will remain that way."

If the bailout eventually tops $1 trillion, however, the size of the Treasury issuance could cause people to start questioning the credit quality of the dollar, he adds.

Other Countries' Bonds

The key to how much confidence foreign investors continue to place in the U.S. will be whether the bailout is structured to ensure the Treasury can recover a significant portion of its investment later on, in contrast to the Chrysler bailout of 30 years ago, says King at National Penn. That can be accomplished either by the government taking equity stakes in the banks it's buying securities from, or buying them at low enough prices or charging a sufficiently high interest rate on loans, he says.

Still, with the future supply and quality of Treasury bonds unknown, it's not a bad idea for risk-averse investors to consider some alternative vehicles.

Money-market funds remain a safe bet for those who want to preserve capital and get some extra yield since the Treasury said last week it will guarantee those accounts.

Buying bonds of other developed countries, such as Switzerland and Australia, which are known for better balancing their budgets and managing their national debt, is another option, financial advisers say. The T. Rowe Price International Bond Fund (RPBIX) is a relatively low-cost way to get exposure to an assortment of countries' bonds. The fund requires a minimum initial investment of $2,500 and currently yields 3.78%. Others planners recommend emerging-market debt, whose yields tend to be higher, but these also carry too much risk to be considered safe havens.

King thinks the best opportunity right now is Fannie and Freddie bonds, whose yields are 1.42% higher than corresponding Treasury notes. That's quite a draw when you consider those bonds would be expected to trade much closer to Treasuries after the government made its guarantee of the agencies' debt explicit, he says.

"Perfect" Bond Asset Class?

Bill Larkin, portfolio manager for fixed income at Cabot Money Management in Salem, Mass., advises people to stay away from Fannie and Freddie debt except for shorter-dated maturities, since the agencies' fate remains to be seen. If they become part of the government, investors will win, whereas if they are broken into pieces, investors will lose because the debt will be much less liquid. He recommends other government agency debt such as that issued by the Federal Home Loan Bank or Ginnie Mae. He also suggests people buy these bonds to hold until maturity instead of buying them to trade them.

Kinder at Picket Fence questions whether there is a perfect bond asset class that can qualify as a safe haven right now. Over the long term, he thinks diversification of your portfolio is the best strategy, even if certain asset classes are currently getting hammered.

Larkin sees Treasury bills primarily as a "fear trade," which unfortunately has come to replace longer-term strategies for many investors overreacting to the abrupt escalation of the financial crisis. People who have fled into T-bills need to figure out a long-term plan, because otherwise they'll just be chasing returns, he says.

He also likes short-term corporate bonds of companies with high credit quality, which provide a low real (inflation-adjusted) return but with less volatility than stocks. This is a good time to buy them because by the time they mature in mid-2009, investors will know if the U.S. economy is in recession or poised to come out of one. As those short-term bonds mature, people can use the returns to dollar-cost average back into a balanced investing strategy comprised of stocks and bonds, he says.

Bogoslaw is a reporter for BusinessWeek's Investing channel.