The basic assumptions that have underpinned hedging strategies for decades are coming undone by the escalating war in Iran.
Government bonds, which typically rise during periods of market stress to cushion equity losses, are now moving in the same direction with stocks as oil markets are going through unprecedented turmoil.
That has forced fund managers to look beyond traditional playbooks. The strategies that have emerged since include selected equities, as well as option overlays and some more esoteric corners of the credit market, in addition to the dollar. Chinese stocks and the Australian dollar are among the targets, while commodities like aluminum and soybean oil have seen an uptick in demand.
At the heart of the reordering is the rising anxiety of a stagflationary shock if a lasting oil-price increase ignites inflation and undercuts global economic growth at the same time. Such a scenario will make the usual policy response of aggressive rate cuts unavailable in case of an economic downturn. Without central bank action, the traditional 60/40 portfolio may once again fail to deliver.
“Since correlations have shifted, the obvious rebalancing between equities and bonds, and instruments such as inflation-linked bonds and gold isn’t protecting portfolios,” said Rajeev de Mello, a global macro portfolio manager at Gama Asset Management. “The opportunity set for effective risk diversifiers has narrowed materially.”
Government bonds, which typically rise during periods of market stress to cushion equity losses, are now moving in the same direction with stocks as oil markets are going through unprecedented turmoil.
That has forced fund managers to look beyond traditional playbooks. The strategies that have emerged since include selected equities, as well as option overlays and some more esoteric corners of the credit market, in addition to the dollar. Chinese stocks and the Australian dollar are among the targets, while commodities like aluminum and soybean oil have seen an uptick in demand.
At the heart of the reordering is the rising anxiety of a stagflationary shock if a lasting oil-price increase ignites inflation and undercuts global economic growth at the same time. Such a scenario will make the usual policy response of aggressive rate cuts unavailable in case of an economic downturn. Without central bank action, the traditional 60/40 portfolio may once again fail to deliver.
“Since correlations have shifted, the obvious rebalancing between equities and bonds, and instruments such as inflation-linked bonds and gold isn’t protecting portfolios,” said Rajeev de Mello, a global macro portfolio manager at Gama Asset Management. “The opportunity set for effective risk diversifiers has narrowed materially.”
Goldman Sachs Asset Management has reduced portfolio sensitivity to market moves with non-linear equity downside protection — strategies that limit losses in case of a large-scale selloff — credit hedges and deploying more more cash to risk hedging strategies.
Invesco has recommended buying commodities shipped through the Strait of Hormuz, including aluminum and grains, while Gama Asset Management has raised dollar cash and hedging via equity futures. Pictet Asset Management’s multi-asset team has cut equities, added put options on stocks and corporate bonds, while increasing dollar exposure.
Pockets of Safety
As investors try to pinpoint pockets of safety, a multi-theme defense spanning stocks exposed to nuclear energy and the digital economy is gaining traction in Asia, according to Bloomberg Intelligence strategists including Shirley Wong.
“Investors should look at a combination of up-in-quality trades in equity, credit and currencies, allocations to alternatives, dynamic risk allocation, and option overlays in equities and across assets,” according to strategists including Christian Mueller-Glissmann, the head of asset allocation research at Goldman Sachs’ Global Investment Research division.
They like selective bearish option spreads, calls on the Euro Stoxx 50 Volatility Index, and puts on European industrials and German equities.
A popular move has been to increase exposure to the US dollar to wait out the market palpitations. Glissmann and his team at Goldman Sachs have turned tactically neutral on stocks and overweight on cash, citing mounting risks that the Middle East conflict may spark an energy shock comparable to those of the 1970s.
“It still feels early to reposition aggressively, especially as recent price action has been quite choppy and would have penalized overly decisive changes,” said Fesa Wibawa, a Singapore-based investment manager at Aberdeen. “We have made some light adjustments to currency risk, using valuation and relative fundamentals as our main guide, while largely looking through near‑term volatility.”
Dollar Positioning
But unlike in 2022, when Russia’s invasion of Ukraine also sparked energy-led market turmoil, the reversal this time is catching a market that was positioned for dollar weakness. The Bloomberg Dollar Spot Index is near its strongest in almost two months and option metrics show traders are betting it can rise to its highest level since December.
“When you look at the dollar pre-war,” the dominant stance was “hedging America,” said Mitul Kotecha, a Barclays Bank strategist in an interview with Bloomberg Television on Wednesday. “Now, it suddenly looks like the dollar’s back as a safe haven” and has rallied on the back of this.
For dollar-funded investors, the costs of hedging currency risk have fallen to an average of 0.28% for eight major Asian currencies, the lowest in over a year, according to three-month forward implied yields compiled by Bloomberg.
Chinese stocks have worked as a surprising haven, holding up on the logic that the country’s more diversified energy supplies make it less reliant on Hormuz shipping lanes and oil imports. Meanwhile, Australia’s dollar has become a refuge, supported by higher oil and gas prices and rising expectations of a near-term rate hike. Malaysia has been another under-the-radar target for its oil and commodities exposure and weakened correlation with other emerging markets, according to Nirgunan Tiruchelvam, an analyst at Aletheia Capital.
Risk Reduction
“When volatility spikes sharply, we often look to sell it rather than buy it, for example by selling puts on assets we are comfortable owning at lower levels,” said Mohit Mirpuri, a partner at SGMC Capital Pte. “We also maintain buffers through short-duration high-quality bonds and a meaningful allocation to precious metals such as gold and silver.”
Hironori Akizawa, a fund manager at Tokio Marine Asset Management said he has been raising cash levels as a prolonged Middle East crisis can raise the probability of stagflation. Danny Wong, chief executive officer of Areca Capital is focusing on stocks tied to high dividends, and local demand.
With traditional correlations in flux, managers say flexibility and selectivity now matter more than textbook diversification.
“Traditional hedges aren’t attracting the usual safe‑haven flows, so we are leaning less on broad cross‑asset hedges and more on selective stock picking and targeted equity risk management,” said Gary Tan, a fund manager at Allspring Global Investments. “We have reduced active risk heading into March by raising some cash and rotating into defensives.”
