Video: Hedge market risks: Review your goals
Get asset allocation right, including quality bonds and alternatives
A diversified asset allocation is one of the best ways to manage market risks, in our view. Government bond markets have been volatile since the conflict began, reflecting concerns about inflation, rate hikes, and fiscal risks. Yet, quality bonds retain their role as portfolio diversifiers, in our view, especially if recession fears begin to rise. We favor medium-duration bonds. An allocation to hedge funds may also help mitigate drawdowns and smooth returns, particularly as cross-asset volatility increases.
Substitute direct equity exposure for capital preservation strategies
Trading geopolitics has historically been a recipe for disappointment. Rather than taking bold directional views, we recommend that investors concerned about downside risks consider capital preservation strategies that offer participation in market upside while potentially limiting some downside risk. In particular, investors should consider using these in areas that have held up well, but which are cyclical, expensive, or susceptible to a prolonged energy shock.
Consider currency hedges
The near-term outlook for the US dollar is likely one of strength amid higher energy prices, but its structural headwinds remain, including the US twin deficits and heavy global allocations to USD assets. Aligning portfolio currencies with liabilities and spending plans may help investors reduce the risk of potentially large currency swings undermining financial goals. According to the latest Global Investment Returns Yearbook, currency risk on average added around 6 percentage points to total portfolio risk. To manage this, investors may want to consider balanced portfolios hedged into their desired currencies, shifting investment grade fixed income holdings into under-allocated currencies, currency hedging overseas equity exposures, or using derivatives such as currency forwards, options, and structured solutions. These instruments, however, introduce additional risks, such as leverage and margin calls.
