The Year Ahead Hedge market risks
Messages in Focus
19 January 2024: This investment view is now outdated. Reach out to your advisor for our current views.
In our downside scenario, weaker economic growth would lead to significant weakness in global equity markets. The good news is that implied equity market volatility has fallen to multi-year lows, making this an attractive time against market risks.
Defensive structured strategies
Defensive structured strategies
We expect positive returns for equities in 2024. But after a robust rally in 2023, further gains look likely to be limited. Meanwhile, a variety of risks could spoil the outlook. While inflation is falling, disappointments could lead to a setback for markets, undermining hopes over the timing, number, and pace of Fed rate cuts. Meanwhile, although our base case is that the war between Hamas and Israel will be contained, the situation is fluid and an escalation that disrupts oil supplies remains possible. Investors looking to hedge against the risk of losses can make use of structured strategies with capital preservation features. Such strategies are particularly attractive in times of higher bond yields and average or below-average implied equity market volatility. Another option to reduce direct exposure is through yield-generating strategies, which are attractive when volatility is above historical averages—as in fixed income markets at present. Capital preservation strategies can also help investors gain exposure to Japanese equities, where, following the strong 2023 rally, options can provide “cheap” exposure to further potential gains thanks to favorable earnings, regulatory, and seasonal trends.
Higher yields and low volatility a boost for capital preservation
Past 5 years 12-month trailing VIX average vs. 10-year US bond yield, based on quarterly data, and current level
Oil and energy stocks
Oil and energy stocks
Investors worried about the potential market impact of further escalation in the Israel-Hamas or Russia-Ukraine wars can consider hedging portfolios through oil market investments or energy stocks. Investors with a high risk tolerance can consider adding exposure via longer-dated Brent contracts, or selling the risk of Brent prices falling.
Gold
Gold
We think gold can provide a potentially effective portfolio hedge against rising geopolitical tensions, and the price of the metal gained in the wake of the Hamas attack on Israel. In December, gold rose to a record high amid hopes of US rate cuts in 2024, which would reduce the opportunity cost of holding a non-interest-bearing asset like gold. Investors looking to add gold can consider buying the metal using options (buying below USD 2,000/oz). Over the longer term, we think a percentage allocation to gold of around mid-single digits is appropriate within a balanced portfolio.
Hedge by positioning for a steeper US yield curve
Hedge by positioning for a steeper US yield curve
Investors concerned about widening US fiscal deficits could consider a steepening trade on the US government bond yield curve—buying 5-year Treasury bonds and selling 10-year ones (on a duration-adjusted basis). This takes advantage of the relatively flat yield curve to enact a “low-cost hedge” against higher longer-dated bond yields. We would expect this position to perform well if investors demand more compensation for holding long-dated Treasuries, or if recession fears lead to lower short-term interest rate expectations.
Macro and multi-strategy hedge funds
Macro and multi-strategy hedge funds
Macro funds could also be an effective hedge and diversifier in 2024. They take advantage of macroeconomic volatility, using their top-down approach to navigate shifts in the economic landscape, central bank policies, and market conditions.
Meanwhile, multi-strategy funds, combining various hedge fund approaches, are also a potentially attractive way to diversify portfolios. These funds are typically highly diversified, reallocate dynamically, and exercise advanced risk management strategies. Investors should be aware of the risks inherent in alternative investments. These include liquidity risk, use of gearing, and limited disclosure requirements.
More investment ideas
Other chapters
Other chapters
This report has been prepared by UBS AG, UBS AG London Branch, UBS Switzerland AG, UBS Financial Services Inc. (UBS FS), UBS AG Singapore Branch, UBS AG Hong Kong Branch, and UBS SuMi TRUST Wealth Management Co., Ltd..
