As banks fail and yields stagnate, safe places for investors’ money

Recent events have prompted investors and businesses to start redeploying their savings to generate a better return while protecting their capital.

Their options include traditional means such as money market funds or short-term treasury bills and more volatile stores of value, such as gold. Some investors have even gone so far as to remove all counterparty risk from their portfolios by investing in cryptocurrencies.

Each option carries its own risks, but all reflect growing concerns about the true security of the US banking system.

In the first half of this year, we saw three of the biggest bank failures in US history, when Silicon Valley Bank, Signature Bank and First Republic all collapsed due to poor risk management. . The FDIC had to step in and take over the banks, guaranteeing $549 billion of assets held on their books in the process.

Unlike many 19th and early 20th century bank failures where depositors had to physically queue outside a bank to withdraw their funds when they felt the bank was no longer safe, this time we witnessed a new phenomenon: digital banking. run. Now, millions of dollars can be transferred from one institution to another in seconds, simply by picking up a phone.

The speed at which a bank can be deemed insolvent has increased dramatically with improvements in communication and technology, prompting businesses, institutions and high net worth individuals to rethink ways to store their money safely.

To be clear, this is not to sound the alarm that the collapse of the banking system is imminent. However, recent history also shows that these are different times, with different and often unknowable risks.

So far, the government has been willing to provide a safety net for depositors caught in a bank failure. But the backstop is not infinite, is not without significant cost to the financial system, and is subject to the political will – some might say whim – of political leaders, and cannot be considered risk free.

In an effort to fight inflation, the Federal Reserve began aggressively raising short-term interest rates in the first quarter of 2022 and did so at its fastest pace – from 0% at the start of 2022. over 5% in May 2023 – since the stagflation period of the late 1970s. Arguably, this created the environment that caused the bank failures described above.

Unfortunately for most savers, banks have been slow to raise the rate they pay depositors.

So what did cautious investors do in response?

Smart depositors have started to move their money into money market instruments because they more closely track the interest rate set by the Fed.

Historically, money market funds have successfully tracked short-term Fed interest rates while maintaining extremely stable value, but they are not FDIC-insured and there is no guarantee that their value net asset will remain at $1. In the fall of 2008, the primary reserve fund’s net asset value fell below $1 when Lehman Brothers filed for bankruptcy, forcing the fund to liquidate.

For clients whose account balances exceed FDIC limits at banks, we have recommended allocations to treasury bills. Treasury bonds, issued by the United States Treasury Department, enjoy the full confidence and credit of the government, making them widely recognized as one of the safest investment options available.

Treasury bills offer high liquidity, as they are issued with different maturities, ranging from a few days to one year, and can be easily traded in the secondary market. As of this writing, treasury bonds are yielding around 5%, a significantly higher rate compared to many similar banking products.

Higher on the risk spectrum is gold, which has been a store of value for literally thousands of years and is considered the oldest store of value and exchange in world history. Unlike fiat currencies, the value of gold is not set by a central banking system and is generally not subject to the political will of governments. Moreover, it has often been a safe haven for investors in times of crisis and financial instability, its value rising as risk increases in the financial system.

An investor can easily gain exposure to gold through highly liquid ETFs which offer the ability to monetize its value very quickly but carry some counterparty risk. Gold can also be held in physical form, which limits counterparty risk but increases its cost and decreases its liquidity.

Gold also tends to maintain or increase in value during periods of declining US dollar. However, gold can be very volatile, does not generate a return (cash flow), and in its physical form can be expensive to store or trade.

Cryptocurrencies, which are not issued or guaranteed by governments and operate independently of the banking system, are gaining popularity as investment assets. Since they are finite in nature, they are not subject to indiscriminate new currency printing, which is a very real risk in a world fueled by deficit spending. They also offer greater, but not perfect, protection against confiscation or restriction of access than government-issued currencies.

However, cryptocurrencies are highly volatile and usually yieldless like traditional banking products, treasury bills, and money market funds. Additionally, cryptocurrencies are subject to regulatory scrutiny and face legal battles around the world. Our firm does not have a recommendation regarding cryptocurrencies given the aforementioned risks. This may change as the crypto ecosystem evolves.

Given the risks and uncertainties prevailing in the current environment, financial institutions are undertaking a revaluation of the assets and liabilities on their balance sheets. Therefore, we strongly recommend that investors follow this example and consider diversifying their investments beyond conventional banking products. It is essential for investors to carefully assess the potential risks and benefits associated with the various alternatives before making informed decisions.

— By Neale Ellis, Chartered Financial Analyst, and Matthew Michaels, Chartered Financial Planner and Chartered Financial Analyst. They are founding partners and co-CIO at Fidelis Capital.