What is flight to quality? Definition and examples

Flight to quality is the movement of money from relatively risky investments to less risky ones. Flight to quality and flight to safety refer to large-scale movements of capital from risky, high-yield investments to low-yield ones. The low-yield investments are also significantly safer than the high-yield ones.

In most cases, this movement of capital follows a major bank failure or corporate collapse. It may also occur when a significantly unsettling event hits the economy.

As is often the case in the world of investments, it is a herd-like shift. In other words, investors copy each other.

Investing Answers has the following definition of the term:

“A flight to quality is the act of moving capital away from “risky” investments and toward “safer” investments due to uncertainty about the overall economy.”

Flight to Quality
Flight to quality occurs when many investors sell risky investments and purchase safe ones.

Flight to quality – what happens?

When there is a flight to safety, two things happen:

1. Investor demand for assets that the government backs increases. We often refer to these assets as gilt-edged securities.

2. Demand for assets that private agents back declines.

When investors have the jitters, i.e., when they are scared, many turn to gold. We see gold is a super-safe investment.

However, we should remember that gold, like any investment, is speculative.

Flight to quality – example

Any rumor or major piece of information that triggers uncertainty can cause a flight to quality. Disappointing GDP growth figures, wars, high fuel prices, for example, can make investors run for over. GDP stands for Gross Domestic Product.

What would have happened if, over the past couple of months, negative news regarding the domestic economy had dominated. Many investors would have sold their risky growth stocks.

They would subsequently have bought safer treasury bills to safeguard their capital.

Treasury bills are short-term maturity promissory notes that the national government issues to raise money. Governments also use them to regulate the money supply.

One or all sectors

The term ‘flight to quality’ may refer to an overall movement in all sectors. However, it may also refer just to one sector in the market.

For example, investors may get rid of junk bonds and invest in high-grade corporate bonds or Treasuries.

Stock market investors may sell aggressive growth stocks and purchase blue-chip stocks.

When investors pull their money out of one country and reinvest it in another or others, it is an international flight to quality.

Flight to liquidity

When there is flight to quality there is also flight to liquidity. The two always happen in tandem.

Flight to liquidity refers to a massive investment shift towards more liquid assets.

As risky investments are less liquid than safer ones, it is not surprising that the two flights occur together.