War rewrites the rules of risk aversion: simultaneous declines across assets occur frequently, traditional hedging proves ineffective, where is money flowing?

The escalation of the Iran war is undermining the basic assumptions that have supported hedge strategies for decades. As the oil market experiences unprecedented volatility, momentum trading is rapidly unwinding, and the trends in stocks and bonds are becoming more aligned. This is forcing fund managers to seek risk-averse options beyond traditional hedge means. In addition to the US dollar, emerging risk assets include some stocks and corporate bonds, options combinations, and some less popular credit market sectors. The Chinese stock market and the Australian dollar are key areas of focus, while demand for commodities such as aluminum and soybean oil is also increasing. At the core of this market restructuring is the growing concern about stagflation impact: if oil prices continue to rise, it could trigger inflation while weakening global economic growth. This has led to a surge in cross-asset correlation, and the market is rethinking the meaning of hedging. Investors' response is a test of the basic effective risk framework since the global financial crisis. Rajeev de Mello, global macro investment portfolio manager at Gama Asset Management, said, "As correlations change, it is evident that the traditional rebalancing between stocks and bonds, as well as inflation-linked bonds and tools like gold, cannot protect portfolios. The range of options for effectively diversifying risks has greatly narrowed." In the current volatile situation, some general strategies are failing because one reason is that inflation risk will render the usual aggressive interest rate cut measures ineffective, even in an economic recession. Without rate cuts, traditional 60/40 investment portfolios may fail again. On the other hand, Goldman Sachs Asset Management has reduced portfolio sensitivity to market volatility through non-linear stock downside protection strategies (limiting losses during massive sell-offs), credit hedges, and increasing cash in risk-hedging strategies. JPMorgan recommends buying commodities transported through the Strait of Hormuz, including aluminum and grains; Gama Asset Management increased its USD cash holdings and hedged through stock futures. Pictet Asset Management's multi-asset team reduced stocks, increased put options on stocks and corporate bonds, and increased USD exposure. In addition to the US dollar, strategists are exploring various forms of hedging. According to industry researchers, such as Shirley Wong, as investors seek safe havens, multi-theme defensive strategies covering stocks related to nuclear and digital economies are becoming more popular in Asia. Strategists, including Christian Mueller-Glissmann, head of asset allocation research at Goldman Sachs Global Investment Research Department, said, "Investors should focus on trading combinations of high-quality assets such as stocks, credit, and currencies, alternative investment allocations, dynamic risk allocations, and equity and cross-asset options overlays." Investors prefer selective put option spreads, call options for the EuroStoxx 50 volatility index, and put options for European industrial stocks and German stocks. A common practice is to increase USD allocations to ride out market volatility. Glissmann and his team at Goldman Sachs took a strategic-neutral position on stocks and increased cash holdings, citing the Middle East conflict potentially sparking an energy crisis comparable to that of the 1970s, a risk that is growing. Aberdeen's Singapore-based investment manager Fesa Wibawa said, "It is still too early to make aggressive portfolio adjustments now, especially given recent price volatility. For now, we have made some minor adjustments to currency risk based on valuation and relative fundamentals while largely ignoring short-term fluctuations." Unlike the energy market turmoil sparked by the Russia-Ukraine war in 2022, the current reversal coincides with market expectations of a weakened USD. The USD spot index is nearing its highest level in nearly two months, and options indicators show traders betting that the index may rise to its highest point since December last year. Barclays strategist Mitul Kotecha said in an interview on Wednesday, "Looking back at the pre-war USD performance, the dominant theme was 'hedging US risk.' Now, the USD seems to have regained its status as a safe haven and, therefore, is rising." According to three-month forward implied yield data, currency risk costs for hedging eight major Asian currencies have fallen to an average of 0.28% for USD-based investors, the lowest level in over a year. Surprisingly, the Chinese stock market has become a safe haven, supported by the logic that China's energy supply is more diversified, reducing reliance on the Strait of Hormuz and oil imports. At the same time, the Australian dollar also benefits from rising oil and gas prices and warming market expectations for rate hikes. Analyst Nirgunan Tiruchelvam from Aletheia Capital also mentioned Malaysia as another investment target that has not been fully considered due to its exposure to oil, commodities, and reduced correlation with other emerging markets. Actively reducing risks Mohit Mirpuri, partner at SGMC Capital Pte, said, "When market volatility surges, we typically choose to sell rather than buy, such as selling put options on assets we believe can still be held at lower levels. We also maintain buffers by holding short-term high-quality bonds and reasonably allocating gold and silver and other precious metals." Hironori Akizawa, fund manager at Tokio Marine Asset Management, said he has been increasing cash holdings due to the prolonged Middle East crisis potentially increasing stagflation risks. Areca Capital CEO Danny Wong focuses on stocks related to high stock dividends and local demand. As traditional correlations are changing, managers say that flexibility and selectivity are now more critical than textbook-style diversification. Gary Tan, fund manager at Allspring Global Investments, said, "Traditional hedging strategies are failing to attract the usual inflows of safe-haven funds, so we have reduced our reliance on broad cross-asset hedging and shifted towards individual stock selection and targeted stock risk management. In March, we raised some cash and rotated investments into defensive assets to lower active risk."