Tactical hedging and strategic diversifying

As highlighted often in our Outlook 2020 report, arguably the main topic for markets is likely to be uncertainty. Although uncertainty is difficult to deal with when making investment decisions, we think that there are solutions that can help investors.

Hedging exposure

As highlighted in the Yield enhancers article, volatility can be used to generate a steady stream of returns through systematic selling of volatility. But in periods of uncertainty, there will also be times to use volatility to hedge opportunistically when the cost/benefit of doing so looks sensible.

As the timing of any sell-off or risk-off episode is uncertain, we see more value in staying invested and using cost-efficient hedging, rather than staying on the sideline and losing value to inflation from holding cash.

Ramping up uncorrelated returns

We also see value in increasing exposure to asset classes, or strategies, that are less correlated with equities and fixed income. In this late-cycle environment, and with the additional layer of geopolitical uncertainty, diversifying exposures or adding assets that have more fundamental drivers, and are less sentiment driven, are steps that should add value in portfolios.

We see several ways to add value. First of all, we continue to like gold as a diversifier in a portfolio. While we do not expect a recession in 2020, risks are increasing and uncertainty is high. Gold has historically been one of the most effective hedges during periods of equity drawdowns.

Second, private markets can be another potent diversifier. Adding private capital to a portfolio has historically decreased risks and improved returns (see chart). Private capital funds usually focus on particular fundamental drivers: the thorough due diligence advisable before making an investment implies that the value of this investment is primarily derived from a company strategy rather than top-down considerations. The illiquidity nature of the asset class also means that shifts in risk sentiment have less impact on private investments than on public markets.

Finally, we see opportunities to diversify in public markets using alternative strategies, such as market neutral or merger arbitrage. Those strategies should only be partially correlated with markets as they tend to focus on fundamental discrepancies arising from a particular situation, such as takeovers. Over time, there should be a pull to realise fundamentals, with little impact arising from top-down drivers.

Investments can fall as well as rise in value. Your capital or the income generated from your investment may be at risk.

This document has been issued by the Investments division at Barclays Private Banking and Overseas Services (“PBOS”) division and is not a product of the Barclays Research department. Any views expressed may differ from those of Barclays Research. All opinions and estimates included in this document constitute our judgment as of the date of the document and may be subject to change without notice. No representation is made as to the accuracy of the assumptions made within, or completeness of, any modeling, scenario analysis or back-testing.

Barclays is not responsible for information stated to be obtained or derived from third party sources or statistical services, and we do not guarantee the information’s accuracy which may be incomplete or condensed.

This document has been prepared for information purposes only and does not constitute a prospectus, an offer, invitation or solicitation to buy or sell securities and is not intended to provide the sole basis for any evaluation of the securities or any other instrument, which may be discussed in it.

Any offer or entry into any transaction requires Barclays’ subsequent formal agreement which will be subject to internal approvals and execution of binding transaction documents. Any past or simulated past performance including back-testing, modeling or scenario analysis contained herein does not predict and is no indication as to future performance. The value of any investment may also fluctuate as a result of market changes.

The value of any investment may also fluctuate as a result of market changes.

Neither Barclays, its affiliates nor any of its directors, officers, employees, representatives or agents, accepts any liability whatsoever for any direct, indirect or consequential losses (in contract, tort or otherwise) arising from the use of this communication or its contents or reliance on the information contained herein, except to the extent this would be prohibited by law or regulation.

This document and the information contained herein may only be distributed and published in jurisdictions in which such distribution and publication is permitted.  You may not distribute this document, in whole or part, without our prior, express written permission. Law or regulation in certain countries may restrict the manner of distribution of this document and persons who come into possession of this document are required to inform themselves of and observe such restrictions.

The contents herein do not constitute investment, legal, tax, accounting or other advice. You should consider your own financial situation, objectives and needs, and conduct your own independent investigation and assessment of the contents of this document, including obtaining investment, legal, tax, accounting and such other advice as you consider necessary or appropriate, before making any investment or other decision.

THIS COMMUNICATION IS PROVIDED FOR INFORMATION PURPOSES ONLY AND IT IS SUBJECT TO CHANGE. IT IS INDICATIVE ONLY AND IS NOT BINDING.