This post was written with contributions from the Gold Strategy Team—Diego Andrade, Robin Tsui and Howard Wen.
Traditionally, investors have used gold tactically with an aim to help preserve wealth in volatile markets or in times of elevated inflation or persistent US dollar weakness. But if we re-evaluate the role of gold through a different lens, we see it can potentially be a valuable strategic asset in all markets.
When building a multi-asset portfolio, investors should consider the potential or forecasted risk-return profile of a particular asset class or market segment, as well as how it will behave relative to other investments. Though asset classes with high forecasted risk-adjusted returns are obviously preferred, investors should also consider looking for asset classes that move differently relative to one another.
With these factors in mind, let’s look at four potential benefits of strategically allocating to gold in a multi-asset portfolio:
Increased portfolio diversification
Potential tail risk mitigation
Preserved purchasing power
Enhanced risk-adjusted returns
1. Increased portfolio diversification
To help control risk, investors diversify their portfolios by holding a wide array of assets that perform differently from one another under various market conditions. A low correlation among the asset classes would lower portfolio volatility and therefore, all else being equal, increase portfolio diversification and enhance the overall risk-adjusted return of the portfolio.
As shown below, the very low or negative historical correlations of gold to major equity markets highlight the potential diversification benefits of adding gold to a multi-asset portfolio.
Source: Bloomberg Finance L.P., State Street Global Advisors, 1/1/2000-9/30/2017
Correlations are calculated from monthly returns in USD. Asset classes are represented by the following indices—Japanese: MSCI Japan Index; MSCI AC World Daily TR Index; US: S&P 500® Index; European: MSCI Europe Index; APAC ex Japan: MSCI ASIA PAC Ex Japan Index; Latin America: MSCI Emerging Markets Latin America Index; Gold: LBMA Gold Price PM.
2. Potential tail risk mitigation
Gold has historically been used to provide potential tail risk mitigation during times of market stress, as it has tended to rise during stock market pullbacks. As shown below, gold delivered competitive returns and outperformed other asset classes during the 2007-2009 Global Financial Crisis. Many asset classes fell in tandem, but gold’s performance was positive. In addition, gold has delivered competitive returns and outperformed other asset classes during a number of other similar Black Swan events.
Source: Bloomberg Finance L.P., 10/1/2007-3/31/2009. Past performance is not a guarantee of future results. Performance above does not reflect charges and expenses associated with the fund or brokerage commissions associated with buying and selling exchange traded funds. Performance above is not meant to represent the performance of any investment product.
Asset classes are represented by the following indices—Gold: GOLDLNPM Index; Agg: Bloomberg Barclays US Aggregate Index; Global Macro: Credit Suisse Global Macro Index; Liquid Alternative Beta: Credit Suisse Liquid Alternative Beta Index; Master Hedge Fund: Credit Suisse Master Hedge Fund Index; Long Short Equity: Credit Suisse Long Short Equity Index; Broad Commodities: Bloomberg Commodity Index; US Large Cap: S&P 500 Index; Global Equities: MSCI World Index; Emerging Equities: MSCI Emerging Markets Index.
3. Preserve purchasing power
Gold has been a long-favored inflation hedge—and for good reason. Gold has exhibited historical effectiveness in preserving purchasing power in various inflationary environments.
Source: Bloomberg Finance L.P., State Street Global Advisors, data from 1/31/1970-9/30/2017. Past performance is not a guarantee of future results. Performance above does not reflect charges and expenses associated with the fund or brokerage commissions associated with buying and selling exchange traded funds. Performance above is not meant to represent the performance of any investment product.
Computed using average monthly gold returns and US CPI Figures from 1/31/1970 to 9/30/2017.
4. Enhanced returns
In addition to diversification and downside protection, a strategic allocation to gold can also potentially enhance long-term portfolio returns. Take a look at the chart below and gold’s performance over the longer time horizons:
Source: Bloomberg Finance, L.P., State Street Global Advisors, as of 9/30/2017
How much should you allocate to gold?
We recently researched1 the impacts of allocations between 2 and 10% to the SPDR Gold Shares (GLD®) ETF in a hypothetical multi-asset portfolio between January 1, 2005 and September 30, 2017. We found a 10% strategic allocation to GLD would have improved the portfolio’s cumulative risk-adjusted returns and lowered its maximum drawdown, as compared to a portfolio without any gold-backed investments.
As the size and number of investable asset classes continue to grow, we believe savvy investors should position gold in a more permanent, strategic role within their multi-asset portfolios.
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