Navigating Turbulent Markets: New Investment Strategies Emerge Amidst Geopolitical Risk

Understanding the Evolving Landscape of Asset Management

For decades, the foundational assumptions underpinning defensive investment strategies have remained remarkably stable. However, the escalating geopolitical tensions, particularly surrounding the conflict involving Iran, are causing these long-held tenets to crumble. Traditionally, government bonds have served as a reliable haven, appreciating during market turmoil to cushion equity downturns. Yet, amidst unprecedented shocks in the oil market, these very bonds have begun moving in lockstep with equities, a phenomenon colloquially termed 'double-whammy' for both asset classes.

Reshaping Portfolios: The Rise of Novel Strategies

In this dynamic and uncertain environment, fund managers are compelled to deviate from conventional investment narratives. The established playbook is no longer sufficient, prompting a pivot towards fresh and more adaptable strategies. Among these emerging approaches, bolstering long positions in the US Dollar has become a prominent choice, a rational move during periods of heightened uncertainty. Beyond this, discerning stock selection, sophisticated options overlay strategies, and exploring less conventional niches within credit markets are proving essential. Chinese equities and the Australian Dollar have emerged as new focal points, while commodities like aluminum and soybean oil are showing signs of reviving demand.

Stagflationary Fears and Asset Revaluation

At the core of this asset revaluation lies a growing market apprehension regarding the potential for a stagflationary shock. The scenario posits that a sustained surge in oil prices could reignite inflation while simultaneously dampening global economic growth. In such a hypothetical environment, the conventional tool of central banks – aggressive interest rate cuts to stimulate the economy – would likely prove ineffective. Without central bank backstops, traditional investment portfolios, such as the classic 60/40 stock-bond allocation, may again fall short of investor expectations.

Shifting Asset Correlations and Redefined Hedging

Rajeev de Mello, Global Macro Portfolio Manager at Gama Asset Management, observes that "since asset correlations have changed, traditional strategies like simple rebalancing between stocks and bonds, and the use of instruments such as inflation-linked bonds and gold, are no longer adequate for portfolio protection." He further notes that "truly effective diversification opportunities are becoming significantly scarcer."

Strategic Responses from Leading Asset Managers

In response to these evolving challenges, major asset management firms have adopted proactive measures. Goldman Sachs Asset Management has sought to reduce its portfolio's sensitivity to market volatility through strategies like 'non-linear equity downside protection,' designed to cap losses during large-scale sell-offs. They have also employed credit hedging and increased allocations to risk-hedging strategies by deploying more cash.

Schroders, meanwhile, recommends investing in commodities requiring transit through the Strait of Hormuz, such as aluminum and grains. Gama Asset Management has increased its holdings of US Dollar cash and implemented equity futures for hedging. The multi-asset team at Pictet Asset Management has reduced its equity exposure, increased its positions in put options on equities and corporate bonds, and simultaneously raised its US Dollar risk exposure.

The Pursuit of New Havens

As investors scramble to find safe havens, multi-themed defensive strategies spanning nuclear energy and digital economy concept stocks are gaining traction in Asia. Strategists, including Shirley Wong from Bloomberg Industry Research, suggest these strategies offer a protective buffer for portfolios. Christian Mueller-Glissmann, Head of Asset Allocation Research at Goldman Sachs Global Investment Research, advises that "investors should focus on 'quality bias' combinations across equities, credit, and FX, allocate to alternative assets, employ dynamic risk allocation, and utilize options overlay strategies in equities and across asset classes."

These strategists tend to favor selective put options spreads, the purchase of call options on the EURO STOXX 50 volatility index, and put options on European industrial and German equities. A currently mainstream approach involves increasing US Dollar assets to navigate periods of market turbulence. Christian Mueller-Glissmann and his team at Goldman Sachs have tactically shifted to a neutral stance on equities and are overweight cash, citing the escalating risk of a 1970s-style energy shock triggered by Middle Eastern conflict.

Fesa Wibawa, Investment Manager at Aberdeen Standard Investments in Singapore, cautions that "it still feels too early to make aggressive reallocations, especially with very volatile price action recently, where being too decisive in repositioning could lead to losses." He adds, "We are primarily guided by valuation and relative fundamentals, making minor adjustments to FX risk while largely disregarding recent fluctuations."

US Dollar, Chinese Equities, and the Aussie: New Anchors?

Unlike the 2022 market upheaval triggered by the Russia-Ukraine conflict, which was largely energy-led, the current market reversal has caught many off guard, as the prevailing view had been for a weaker US Dollar. The Bloomberg Dollar Spot Index is currently approaching its strongest level in two months, and options metrics suggest traders are betting on the index reaching its highest point since December. Mitul Kotecha, a strategist at Barclays, noted in a Bloomberg Television interview last Wednesday that "pre-conflict, the consensus view was to hedge US risk. But now, the dollar seems to have suddenly returned to the safe-haven pedestal."

For investors who finance in US Dollars, the cost of hedging against the exchange rate risk of eight major Asian currencies has fallen to an average of 0.28%, the lowest in over a year, according to three-month forward implied yield data compiled by Bloomberg.

Chinese equities have also served as a safe haven, underpinned by the logic that China's more diversified energy supply makes it less reliant on Strait of Hormuz shipping routes and oil imports. Meanwhile, the Australian Dollar has become a haven for capital, supported by rising oil and gas prices and the prospect of near-term interest rate hikes. Nirgunan Tiruchelvam, an analyst at Aletheia Capital, points to Malaysia as another relatively hidden investment target, owing to its exposure to oil and commodities and its diminishing correlation with other emerging markets.

Mitigating Risk in a Volatile Environment

Mohit Mirpuri, Partner at SGMC Capital Pte, explains that "when volatility spikes significantly, we tend to sell volatility rather than buy it, for example, selling puts on assets we might be happy to buy on dips." He adds, "We also maintain buffer space through short-duration, high-quality bonds and meaningful allocations to precious metals like gold and silver."

Hironori Akizawa, a fund manager at Tokio Marine Asset Management, has been increasing his cash levels, as a protracted Middle East crisis could increase the probability of stagflation. Danny Wong, CEO of Areca Capital, is focusing on stocks linked to high dividends and domestic demand.

With significant fluctuations in traditional asset correlations, fund managers generally agree that current investing emphasizes flexibility and careful selection over rote, textbook diversification. Gary Tan, a fund manager at Allspring Global Investments, admits that "traditional hedging tools are no longer attracting the usual hedge fund inflows, and therefore, we are not overly reliant on broad cross-asset hedging, but rather more inclined towards discerning individual stock selection and targeted equity risk management." He adds, "Prior to entering March, we had reduced our active risk by increasing cash and rotating into defensive sectors."