CIO expects positive returns on the major asset classes in 2024. Investors can consider a range of strategies to smooth portfolio returns and mitigate drawdowns. (UBS)

The rally has been driven by optimism that a swift fall in US inflation will avert the need for further rate hikes from the Federal Reserve—and pave the way for rate cuts in 2024. Meanwhile, the S&P 500’s latest earnings season pointed to a return to profit growth after three quarters of contraction.

Our base case is for further modest equity gains in 2024, with the S&P 500 Index ending the year around 4,700 from 4,547 as of 21 November. As inflation continues to fall and growth moderates, we are even more positive on quality fixed income and see it as a good time to be adding to multi-asset portfolios.

But an unusually wide range of risks could still spoil the outlook. While inflation is declining, markets could be unsettled by any slowing of this process. The wars between Russia and Ukraine and between Israel and Hamas both have the potential to trigger volatility. And the US presidential election takes place against a background of an increasingly dysfunctional budget process.

We see a variety of ways investors can reduce threats to their portfolios:

Investors looking to position more defensively can make use of structured investments with capital preservation features. Such strategies are particularly attractive in times of higher bond yields and average or below-average implied equity market volatility. At present, the combination is close to the most appealing in terms of downside protection versus upside participation since the global financial crisis. Another option to reduce direct exposure is through yield-generating strategies, which are attractive when volatility is high—as in the fixed income markets at present.

Investors worried about the potential market impact of further escalation in the Israel-Hamas or Russia-Ukraine wars can consider hedging portfolios through oil market investments or energy stocks. Investors with a high risk-tolerance can consider adding exposure via longer-dated Brent contracts, which currently trade at a discount to spot prices, or selling the risk of Brent prices falling. Gold offers a potentially effective hedge against a deterioration in geopolitical conflicts. While uncertainty over interest rates could keep gold choppy in the near term, investors looking to add gold can consider buying the metal using options (buying below USD 1,900/oz). We think investors with existing long gold positions should hold onto them in anticipation of a recovery over the next 6–12 months.

Macro funds could also be an effective hedge and diversifier in 2024. They take advantage of macroeconomic volatility, using their top-down approach to navigate shifts in the economic landscape, central bank policies, and market conditions. Meanwhile, multi-strategy funds, combining various hedge fund approaches, are also a potentially attractive way to diversify portfolios. These funds are typically highly diversified, reallocate dynamically, and exercise advanced risk management strategies. Investors should be aware of the risks inherent in alternative investments. These include liquidity risk, use of gearing, and limited disclosure requirements.

So, while we expect positive returns on the major asset classes in 2024, investors can consider a range of strategies to smooth portfolio returns and mitigate drawdowns.

For more details on these ideas and more, click here for our Year Ahead 2024: A new world.

Main contributors - Solita Marcelli, Mark Haefele, Moritz Vontobel, Sagar Khandelwal, Christopher Swann, Vincent Heaney, Jennifer Stahmer

Read the original report: Risks remain despite upbeat mood in equity markets, 21 November 2023.