Volatility is back with a vengeance. Having surged almost 45 per cent between mid-March and the end of August, the MSCI All Country World Index, a gauge of global stocks, has since lost 1.5 per cent, and was down by as much as 7.5 per cent in the first three weeks of September. Mounting strains – a resurgence in Covid-19 cases, a sell-off in technology shares, the failure of the US Congress to approve additional stimulus measures and the US’ turbulent presidential election – have put equity markets under renewed pressure, causing the S&P 500 index to fall nearly 4 per cent in September, its worst month since March. As if the spike in volatility were not troubling enough, investors must contend with another, potentially more severe, problem: the dearth, and increasing ineffectiveness, of safe haven assets. Traditional sanctuaries, such as the sovereign bonds of the most creditworthy countries, and the currencies of Japan and Switzerland, are providing scant protection against declines in stocks. Last month, when tech shares came under heavy selling pressure, the yields on 10-year and 30-year US Treasury bonds barely budged, while the Japanese yen held firm against the US dollar. Even the price of gold, another popular refuge, fell more than 4 per cent. In a sign of the extent to which defensive assets are no longer shielding investors from losses, JPMorgan noted in a report published last Friday that a group of traditional hedges had just delivered their worst monthly performance during a major stock market sell-off since the 2008 financial crisis, and are “functioning about as well as fire insurance that covers just one bedroom in the house”. The most conspicuous failure of hedging is in government bonds. During the acute phase of the euro-zone crisis in 2011-12, investors could rely on sharp gains in German sovereign debt to help offset heavy losses in stock markets. This year, 10-year German bonds have returned practically nothing since stocks hit an all-time high in late February. This is because German debt was already trading with negative yields before the virus struck, and had little scope to rally further. The same phenomenon can be observed in the US debt market. Benchmark 10-year Treasury yields were close to 2 per cent at the end of 2019, but have since dropped to 0.7 per cent due to the Federal Reserve’s massive stimulus programme. While Treasury yields fell sharply when the pandemic erupted, causing prices to rise, they have been more or less flat since the end of March, failing to provide an effective hedge during last month’s sell-off. Although Treasury yields could drop further if the Fed joins its Japanese and European counterparts by introducing negative interest rates – a measure America’s central bank is understandably reluctant to take – the efficacy and reliability of bonds with wafer-thin, or negative, yields as a hedging strategy have been severely compromised. Not only is this forcing investors to question the rationale behind the 60/40 rule – the traditional composition of investment portfolios in which 60 per cent of money is allocated to stocks and 40 per cent to government bonds – it is prompting a much-needed reassessment of the characteristics of safe havens. With traditional refuges failing to insulate portfolios from sharp sell-offs, other, less established, hedges are attracting interest from investors. Emerging markets, several of which have had stronger credit ratings than some Southern European economies, are proving an increasingly effective hedge, especially the debt of the most creditworthy developing economies. Not only are emerging market bonds higher yielding, they also benefit from more credible policymaking regimes which allow central banks to cut rates during periods of turmoil, providing more scope for yields to fall, and delivering stronger returns. Hong Kong’s pension plan grows to 20-year high after stellar quarter China’s government debt market , the world’s second largest, has been one of the main beneficiaries of the “hunt for yield”, with foreign ownership of Chinese bonds now approaching 10 per cent. The country’s 10-year yield currently stands just above 3 per cent and, given the People’s Bank of China’s “ drip-irrigation approach ” to easing policy, it has more scope to decline for a longer period. Equity investors should also consider the protection offered by assets currently benefiting from support from the big central banks. Investment grade corporate bonds proved remarkably resilient during last month’s sell-off, and could become a defensive asset if the Fed extends the duration of its purchases of corporate debt. Even the tech sector, which led last month’s declines in equities, has emerged as the safest corner of stock markets due to the dominant players’ cash-generating capacity, robust balance sheets and business models that are ideally suited to the world of lockdowns and social distancing. This does not mean that investors should start piling into emerging market debt, corporate bonds and tech stocks to protect themselves against further volatility. It does suggest, however, that investment portfolios need to be more diversified as traditional haven assets are found wanting. Nicholas Spiro is a partner at Lauressa Advisory