(UBS)
The perfect hedge would depend on the nature of the crisis, which is impossible to predict. Even so, investors can apply these general principles:
Diversify geographically. Most geopolitical crises will impact some nations more than others, such as South Korea during North Korea’s missile tests, or Russia and Ukraine during the current crisis. Since you cannot anticipate where the flare-up will happen, maintaining a geographically diverse portfolio is the favored basic hedge. Geographical diversification can be particularly important for investors based in emerging economies, where policy setbacks or conflicts can have a more severe and lasting effect on the home equity and fixed income markets, as well as the currency.
Consider some exposure to “safe-haven” assets. These can include gold, the Swiss franc, US dollar, Japanese yen, US Treasuries, low-beta stocks, and select hedge fund strategies. However, this is not a static category. For example, if the political crisis threatens to radically boost energy prices and therefore inflation—but is unlikely to spark a recession—high-quality government bonds might not be the best source of protection, especially if yields are already low. But a selection of defensive investments—diversified in their own right—can help reduce volatility.
Explore hedges that have upside potential, even if the crisis does not escalate. The optimal hedge is one that you expect to rise in value over the long term, even if the geopolitical crisis is resolved, but would outperform if the crisis escalates.
Keep a long-term focus. Geopolitical risks seldom have more than a fleeting impact. So, we recommending avoiding getting caught up in any panic response and to not sell into the crisis. This should ensure you are well placed to benefit from the rebound. Political risks can capture market attention for anything from a few days or weeks, then disappear just as suddenly as they fade from the headlines. In addition, there is almost never a time when there is no potentially significant political crisis on the horizon, so put them in perspective.
Build a “buffer” against volatility. When it comes to managing risk in your portfolio—whether from a geopolitical shock or another source—the priority is to make sure that your portfolio is designed so that short-term market volatility does not interrupt your ability to meet your goals. One solution is to build a Liquidity strategy by setting aside enough cash, bonds, and borrowing capacity to meet the next 3–5 years of cash flow needs from your invested assets. Historically, most diversified portfolios have fully recovered from even the worst market losses in 3–5 years, so the Liquidity strategy can provide you with the resources that you need to “wait out” the recovery of the rest of your portfolio. Being able to maintain your lifestyle and avoid the risk of locking in otherwise-temporary losses in your long-term investments can create a powerful buffer against geopolitical shocks, providing you with confidence and safety even if they become a more serious market disruption, such as a bear market.
Select hedge fund strategies can increase portfolio stability and diversification. Due to their focus on risk management and downside mitigation, hedge funds have historically added differentiated returns in multi-asset portfolios, providing some protection against unexpected sell-offs and helping to reduce portfolio swings, especially during times of economic slowdown or recession. The path toward broader geopolitical uncertainty is likely to contribute to volatility, creating opportunities for hedge funds to generate alpha and potentially achieve higher returns. So, investors concerned about geopolitical and economic uncertainty can add exposure to hedge funds as part of a well-diversified portfolio.
For much more, see Geopolitical risks: An investor's guide .
