Hedging trade war and inflation risks
While still low, the likelihood of higher-for-longer inflation is now greater – and individuals should factor this into how they invest
IT WAS always going to be exciting.
US President Donald Trump clearly likes to shake everything up and see how things land. This innovative approach may lead to solutions that others have missed.
But at the same time, it increases uncertainty – something that CEOs and investors do not like.
Trade tensions are making headlines, but the key (related) risk is the inflation outlook. The probability of higher-for-longer inflation, while still low, has increased – and this should be factored into how you invest.
There are three ways that investors can deal with the uncertainty stemming from the new administration.
One of the approaches is to stop everything that you are doing and focus on intraday trading based on the latest tweet. At the other extreme, you can bury your head in the sand or go on a very long holiday to somewhere without Wi-Fi and mobile coverage; I must admit this is tempting.
In between those extremes is the more appropriate approach: Listen to what is going on, try to decipher what it might mean for your investments, while trying to cut through the noise of tweets, threats and policy statements, without losing sight of your end goal.
When put this way, it is obvious which approach is likely best for your physical, emotional and financial health. But what does it mean in practice?
Hedging in practice
Since 2022, when inflation surged and caused equities and bonds to fall sharply, many pronounced the death of the 60/40 (60 per cent equity, 40 per cent bond) portfolio.
Our 2024 theme embraced this positive correlation between bonds and equities; as falling bond yields would support equities. This worked out really well for investors; our balanced strategy generated returns of more than 11 per cent.
This year, we continue to see positive returns for equities and bonds. However, there is a niggling concern that the positive correlation could return to bite us, should inflation surprise on the upside.
President Trump’s immigration and tariff policies are potentially inflationary. While our central scenario is that this will not get in the way of stable or slightly lower inflation, the risks have clearly increased.
How should investors deal with this higher risk? I do not believe that throwing out the 60/40 portfolio makes sense for an investor with a balanced risk profile.
Rather, I suggest allocating around 45 per cent to global equities and 30 per cent to global bond markets, and then supplementing this with another 25 per cent in other asset classes.
Gold and private credit
Gold is the first port of call for us. We assign a 5 per cent weight to the precious metal in our balanced portfolio.
It is doing incredibly well, rising 30 per cent over the past 12 months, and more than 10 per cent so far this year.
We are currently close to the top of a rising trend channel, which suggests the risk of some consolidation or correction in the near term. However, any dip towards US$2700 to US$2750 would be a great area to top up allocations, in my opinion.
Thereafter, we look to other alternative asset classes. My next port of call would be private credit. We continue to see attractive expected returns for this asset class, regardless of the stage of the business cycle. It also has the benefit of giving investors exposures to floating-rate debt.
While we believe that the barrier to the US Federal Reserve hiking interest rates in 2025 is quite high, inflation could force the central bank’s hand if it were to pick up again.
Floating-rate debt would increase the yield on offer to investors in such a scenario. While historically the focus here has been on the US, we are starting to see more opportunities in Europe as the private-credit market there develops.
Other alternative assets
Hedge-fund strategies have the potential to diversify your exposures. There are several areas within this space that can help improve the risk-reward of a portfolio.
Macro, systematic and trend-following strategies are among the ones with the best ability to deliver strong returns in an environment where a 60/40 portfolio performs poorly.
Portfolio managers in these areas can take short positions in equity or bond indices, as well as long positions in focused areas that are likely to benefit from higher inflation and interest rates.
Other areas within the hedge-fund strategy space include equity long-short, mergers and acquisition arbitrage and relative value (credit), which can help improve the risk-return profile of a portfolio.
The final area to look at is private equity. While a rising inflation and interest rate environment can be challenging for the asset class, we think that the current set-up for it is quite positive.
We expect the initial public offering market to open up in 2025, which means that investors will be more likely to realise their returns in the coming 12 to 18 months.
Overall, no one wants a resurgence of inflation, as it would clearly be challenging for investments. But the above assets could help you weather any such scenario.
The writer is global chief investment officer for Standard Chartered Bank’s wealth solutions unit
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