A flight-to-quality is a movement of funds from investments which are deemed risky to investments which are considered more safe and stable. At times, such activities can change an entire market as numerous investors move their investments around to address concerns, while in other instances, a flight-to-quality may occur on a small scale only and not have an impact on the market at large. There are a number of reasons why investors might opt to move their funds from high risk to low risk investments.
For an individual investor, sometimes a flight-to-quality occurs as part of a diversification effort. An investor might be concerned that a portfolio is not well balanced and that it could pose a risk if the market became volatile. Consequently, some shifts might be made to spread investments out more evenly for safety. For example, an investor might take money out of the stock market and invest in government backed securities.
Investors as a group often engage in a flight-to-quality when the market becomes volatile. On an international scale, concerns about political activities in some nations might lead investors to pull out because they are worried about losing their money. In this case, the funds are moved from one country to another to find higher quality investments. Investments can also be moved within a country as investors concentrate their funds in stocks with a reliable performance record and in government backed securities, by contrast with high risk stocks and private securities.
While the flight-to-quality is often a response to market instability, the mass movement of investments can also destabilize the market further. This could be considered a form of financial contagion, as savvy investors move their money, making the market more unstable and leading other investors to follow suit. If the movement continues unchecked, it could cause a stock market crash as investors panic and attempt to make their investments as safe as possible.
One characteristic of a flight-to-quality is that it is often a flight-to-liquidity as well. Investors who are concerned about volatility may prefer more liquid assets so that they have flexibility and can move their funds around more easily. Locking up funds in long term and complex investments is not desirable because it removes the ability to adapt quickly to a changing market. However, each investor has an individual strategy, and some people may feel that taking long term investment positions is a good strategic move.