We are constantly told that higher risk brings higher returns. In these conversations, we tend to talk about multibaggers, the next big thing, the moat and the upsides. But not about risks. The rapid-fire disclaimer at the end of every mutual fund ad: "Mutual Fund investments are subject to market risks..." got neglected with the "Mutual Funds Sahi Hai" slogan. The recent swings in Indian equities are a reminder of those bitter risks we ignored.
Now, the ball is in banks' and corporates' court to make fixed deposits and bonds great again, from the marketing angle. Safety may not be exciting, but it becomes a lot more interesting when uncertainty rises.
That brings us to risk-free assets. A risk-free asset is, in simple terms, one that does not default. Government bonds, especially US Treasuries, are usually treated as the benchmark. But today, investors are questioning the meaning of risk-free, whether US government bonds still are, and how to price the shocks reshaping the world.
Three Foundations of Risk-Free Asset
At its philosophical core, a risk-free asset rests on three conditions.
The first is impatience. People don't like to wait, especially for money. Most would rather have Rs 100 today than Rs 100 a year later, so lenders expect extra compensation for waiting, which we call interest. That's how modern financial systems are built. Usually, the longer you wait, the more interest you charge.
The second is sovereign credibility. With most borrowers — whether a friend, a company, or even a bank — there is always some chance of not getting our own money. Governments are different. They have the power to raise taxes, create money, and rely on institutions and legal systems that support these promises. That is why government bonds are often treated as the closest thing to a risk-free asset.
The third is the stability of the value. Even if a government pays as promised, inflation may erode the purchasing power. A truly risk-free asset, therefore, requires confidence both in the promise and in the value of what is paid. We see many low and middle-income countries issuing bonds denominated in US dollars due to currency volatility and hyperinflation.
These three layers largely explain why government bonds, especially US Treasury, sit at the centre of the global financial system.
Looking Inside Sovereign Credibility
Impatience is largely a human trait, while inflation management is an economic issue. Sovereign credibility, however, is a blend of many things and thus cannot be treated as a single idea.
A recent essay by Shanaka Anslem Perera, independent analyst, entrepreneur and author, offers a conceptual framework for this issue.
Historically, the world kept the US Treasury yield as a benchmark for the global risk-free rate of interest. He argues that it is rather a stack of various functions, and not a single number. He writes, "The United States Treasury performed five jobs for the global system so completely that almost no one thought to separate them." They are:
- Reserve asset for central banks
- Collateral utility in markets
- Cash-like parking place for liquidity
- Long-term store of value
- Settlement asset in the clearing system
Because all these functions were bundled into a single asset, they were treated as inseparable. So, let's separate some of them for our analysis.
Unbundling of Safety
Recent research shows that we need to look at the US dollar and the US Treasury separately. Wenxin Du, Ritt Keerati and Jesse Schreger find that while demand for dollars remains strong, the extra premium investors once paid to hold long-dated US Treasury bonds has declined significantly.
These bonds enjoyed lower yields because investors considered them one of the safest assets in the world. This assumption is changing, not because people think the US may default, but because of rising fiscal deficits, Treasury issuances and uncertainty around future debt dynamics. Therefore, yields on long-tenor bonds have risen-a story I covered recently in detail.
However, the picture looks very different for the short-tenor bonds. The distinction became visible during the market turmoil following the April 2025 Trump tariffs episode. A recent working paper by Viral Acharya and Toomas Laarits finds that while long-tenor bonds lost some of their safe-haven appeal, shorter-dated Treasuries continued to attract strong demand as safe assets. Short-term Treasuries continue to enjoy strong demand because they fulfil a different role. They function as cash-like instruments, collateral, and liquidity reserves for financial institutions.
Recent geopolitical developments have also challenged another assumption: that ownership and access are the same thing. Questions surrounding sanctions, reserve freezes, payment networks and settlement systems have highlighted that accessibility itself may be an important component of safety.
Take Russia. It couldn't access a large part of its reserves after sanctions. That was a warning for many countries. After that episode, countries focused on control, accessibility and diversification of their reserves. India's decision to bring back its gold reserves from overseas vaults reflects the same thinking.
Similarly, central banks have diversified a part of their reserves towards gold. Again, it does not indicate a complete loss of confidence in the dollar. Instead, it shows that reserve management has become a balancing act with multiple objectives, including liquidity, access, diversification and resilience. Different assets satisfy different aspects of those objectives.
Final Take
For decades, a single instrument simultaneously served as a reserve asset, collateral, liquidity buffer, long-term store of value, and universally accepted claim. The key lesson from this framework was analysing these functions separately.
The current observations might be a temporary phase in a much larger 30-50-year cycle. But if these trends persist, it warrants an evaluation of financial safety. An asset may remain highly liquid while becoming less attractive as a long-term store of value. It may remain creditworthy while becoming harder to access under certain geopolitical conditions. It may retain reserve status while losing some of its traditional advantages elsewhere.
Even after analysing these functions separately, we may still arrive at the same conclusion: there is no meaningful alternative to the US-centred financial system. But at least we will have better metrics to track changes in its strengths and vulnerabilities. The real issue is not whether the dollar or Treasuries are gaining or losing importance, but how we think about risk-free assets and returns in the first place.
Disclaimer: The views expressed in this article are solely those of the author and do not necessarily reflect the opinion of NDTV Profit or its affiliates. Readers are advised to conduct their own research or consult a qualified professional before making any investment or business decisions. NDTV Profit does not guarantee the accuracy, completeness, or reliability of the information presented in this article.
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