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 yields in USD, EUR, and GBP have risen significantly to account for higher oil prices. But they may not climb higher even if oil prices remain elevated, as investors will likely begin to price in adverse growth effects and the potential for lower rates. We therefore like locking in elevated yields up to 10 years out on the curve. And we believe quality bonds will retain their role as portfolio diversifiers, especially if recession fears begin to rise. We favor short- to medium-maturity bonds in general. For investors still concerned about the longer-term inflationary outlook and seeking a less correlated asset, an allocation to US inflation-linked bonds (TIPS) may be preferred to nominal bonds for those investors. 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.
Capital preservation notes can be customized for tenor, loss avoidance, and participation, allowing investors to tailor the degree of capital preservation and participation in market gains. Variants such as “bearish notes” and “twin-win” strategies can offer flexibility for different market views. The predefined loss limits can help investors stay invested during downturns, reducing the temptation to sell and lock in losses.
The sharp move higher in many governments’ shorter-dated bonds could make zero-coupon bonds cheaper, increasing the capital available for options and thus participation in market gains. However, investors must also monitor implied volatility, as higher option prices can reduce participation rates.
Build a liquidity strategy
Liquidity planning is a key consideration for private investors, especially those who depend on their assets to fund their lifestyle. An effective liquidity strategy should be designed to allow investors to meet their spending needs without being forced to sell investments during unfavorable market conditions. This liquidity reserve is intended as a complement to a core allocation in a globally diversified portfolio.
Tier I (Everyday cash, up to 12 months) To provide access to funds for daily living expenses, and any unforeseen short-term needs. Most investors will have reasonable visibility of their spending needs over the next year and should size this allocation accordingly. Investment instruments over this horizon should prioritize capital safety and liquidity, offering peace of mind and financial stability. Tier II (Core liquidity, 1-3 years) To cover planned expenses over the next one to three years—including larger purchases, tax payments, or anticipated lifestyle costs. Investments over this horizon should aim to deliver positive real returns by balancing modest yield enhancement with low risk, serving as a buffer to avoid liquidating long-term assets during periods of market volatility. Tier III (Investment cash, 3-5 years) To set aside wealth for potential medium-term needs—including possible health care costs or major life events, or to replenish everyday cash or core liquidity. By accepting moderate risk and reduced liquidity, “investment cash” can target positive real returns and help safeguard against having to sell down core portfolio holdings during drawdowns. This supports long-term financial sustainability and helps weather market downturns.
