In today’s uncertain world, hedging liquid alternatives can help reduce drawdown risk and smooth outcomes. However, investors must decide whether the cost of carry is worth bearing and how to implement such strategies if so. Fidelity International’s Rahul Srivatsa – Portfolio Manager, Megan Chen – Director of Client Solutions and Stefan Rusev – Senior Strategist, offer some insights and a full white paper.
In today’s world of geopolitical fragmentation, macro volatility is heightened and the range of plausible market outcomes has widened.
Traditional diversifiers can be less dependable and concentration in markets can amplify drawdowns. This more challenging environment demands a different investment approach to that which has worked in the past.
For example – liquid alternatives that offer different risk and return characteristics to equities and bonds should be considered to diversify portfolio returns and improve resilience.
Hedging strategies are those which tend to perform well in ‘risk off’ markets. They seek to introduce a asymmetric payoff profile, aiming for materially better outcomes in down markets than the upside sacrificed in up markets through the cost of carry.
An allocation to hedging liquid alternatives can provide meaningful downside protection, but investors should be clear on the type of risk they are seeking to address: ‘core’ risks relate to the more frequent setbacks and drawdowns that can occur through a normal market cycle, while ‘tail’ risks relate to rarer, more severe market shocks.
There are significant differences across hedging approaches, and outcomes can vary materially depending on design and implementation choices.
Selecting the most appropriate approach requires a robust research process and a portfolio construction framework that is aligned to objectives, constraints and tolerance for ongoing hedging costs.
Ultimately, hedging can help cushion portfolios when markets fall, but it is not free. We must decide if the cost is worth bearing and how much protection is appropriate.
In practice, this involves several considerations, including the market environment and the specific risks to hedge.
We can help investors arrive at a thoughtful, dynamic hedging strategy that can be adapted through time as circumstances change.
The full white paper is available to view on the Macro Views page on the Fidelity International website.
Past performance is not a reliable guide to future returns. You may not get back the amount originally invested, and tax rules can change over time. The writer’s views are their own and do not constitute financial advice.
This information should not be relied upon by retail clients or investment professionals. Reference to any particular investment does not constitute a recommendation to buy or sell the investment.
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