Middle East Conflict Shakes Decades-Old Hedging Strategies as Investors Seek New Safe Havens

Source: Global Market Report

The escalation of Iran’s conflict is unraveling decades-old assumptions that supported hedging strategies.

As the oil market experiences unprecedented turmoil and momentum trading quickly retreats, stocks and bonds are fluctuating in tandem. This has forced fund managers to seek solutions beyond traditional hedging tools. New safe havens outside the dollar include select stocks and corporate bonds, overlay options strategies, and some less common areas in the credit markets. Chinese stocks and the Australian dollar are becoming popular targets, with demand for commodities like aluminum and soybean oil also rising.

The core of this reallocation is market anxiety that rising oil prices could trigger stagflation—driving up inflation while dragging down global economic growth. This has led to a sharp increase in cross-asset correlations, prompting investors to reassess the meaning of hedging strategies. How they choose to respond will test the risk management frameworks that have been in place since the global financial crisis.

“Because correlations have changed, rebalancing between stocks and bonds, as well as tools like inflation-linked bonds and gold, can no longer protect portfolios,” said Rajeev de Mello, Global Macro Portfolio Manager at Gama Asset Management. “Opportunities for effective risk diversification have greatly diminished.”

One reason traditional strategies are failing amid current turbulence is that inflation risks make aggressive rate cuts during economic downturns unfeasible. If central banks remain steadfast, the classic 60/40 investment portfolio could once again falter.

Goldman Sachs Asset Management has reduced portfolio sensitivity to market swings through various means, including nonlinear downside protection strategies for stocks, credit hedges, and deploying more cash into risk hedging.

Gama Asset Management has increased its dollar cash holdings and used stock futures for hedging. Pictet Asset Management’s multi-asset team has cut stock holdings, increased put options on stocks and corporate bonds, and raised its dollar exposure.

Safe Havens

Industry research strategists like Shirley Wong note that as investors seek safe havens, multi-theme defensive strategies covering nuclear energy and digital economy stocks are gaining popularity in Asia.

“Investors should consider trading portfolios of high-quality assets such as stocks, credit, and currencies, allocate to alternative investments, implement dynamic risk allocation, and overlay options strategies across stocks and other asset classes,” said Christian Mueller-Glissmann, Head of Asset Allocation Research at Goldman Sachs Global Investment Research.

They favor selective put spreads, euro Stoxx 50 volatility index call options, and put options on European industrial stocks and German equities.

A popular approach is to increase dollar exposure and wait for market volatility to subside. Goldman’s Glissmann and his team have shifted to a tactically neutral stance on stocks, overweight cash, citing rising risks comparable to the 1970s energy crisis triggered by Middle East conflicts.

“It’s too early for aggressive position adjustments, especially given recent volatile price movements. Major early moves could lead to losses,” said Fesa Wibawa, Investment Manager at Aberdeen in Singapore. “We mainly rely on valuation and relative fundamentals, with some minor adjustments for FX risk, while largely ignoring short-term volatility.”

Dollar

Unlike the 2022 Russia-Ukraine conflict, which also caused energy market turmoil, this time the market expects the dollar to weaken. The Bloomberg dollar spot index is near a two-month high, and options indicators show traders betting on it rising to levels not seen since December last year.

Barclays strategist Mitul Kotecha said in an interview Wednesday, “Looking at the dollar’s pre-war trend,” the mainstream view was “hedging US risks.” “Now, the dollar has suddenly regained its safe-haven status,” supporting its rise.

Bloomberg’s implied three-month forward yield spread shows that for dollar-funded investors, the cost of hedging foreign exchange risk for eight major Asian currencies has fallen to an average of 0.28%, the lowest in over a year.

Chinese stocks have unexpectedly become a safe haven, based on the logic that the country’s diversified energy supply reduces reliance on the Strait of Hormuz and oil imports. Meanwhile, the Australian dollar has also become a safe haven, benefiting from rising oil and gas prices and market expectations of recent rate hikes. Nirgunan Tiruchelvam, an analyst at Aletheia Capital, notes that Malaysia, with its holdings of oil and commodities and weaker correlation with other emerging markets, is another lesser-known safe haven.