BUILDING
PORTFOLIO
RESILIENCE

A construction crane

We see two broad categories of market risks: known risks, like runaway inflation or the outcome of a major election, and ‘unknown risks’ – Black Swan events that cannot be anticipated by markets. The outbreak of the Covid-19 pandemic in 2020 was one notable example of an ‘unknown risk’, but the category spans other unpredictable events like large scale cyber or terrorist attacks and natural disasters, among others. So, how can investors position for the known and the unknown?

Capital at risk. The value of investments and the income from them can fall as well as rise and are not guaranteed. Investors may not get back the amount originally invested.

This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any financial instrument or product or to adopt any investment strategy.

POSITIONING FOR KNOWN RISKS

Inflation has been in focus in 2021, as the global activity restart has taken hold and rising demand has met supply chain disruption. Looking ahead, we expect a higher inflation regime in the medium term – with a more muted monetary response than in the past. We think that medium-term inflation is still an underappreciated risk, and advocate building inflation protection into portfolios through a multi-asset lens.

Video

With inflation top of mind for investors, watch Head of Investment Strategy Karim Chedid and Fixed Income strategist Natacha Blackman discuss how investors can prepare portfolios for higher inflation.

Karim Chedid: Hello, I’m Karim Chedid, Head of Investment Strategy for iShares EMEA. With the activity restart having peaked, we see its unusual dynamics, particularly around supply shocks, driving price pressures upwards: higher inflation is real, and we see it persisting over 2022. I’ll now hand over to iShares Fixed Income product strategist Natacha Blackman, for more on how investors can position portfolios for more persistent inflation using bonds, equities, and alternatives.

 

Natacha Blackman: When it comes to positioning portfolios for rising inflation, investors have a number of options across asset classes. One of the most explicit ways would be inflation-linked bonds, which are designed to protect investors from the risk of higher-than-expected inflation. The principal and interest payments of inflation-linked bonds adjust to compensate for inflation, unlike traditional nominal bonds where there are no inflation adjustments. Shorter-maturity inflation-linked bonds can help limit duration risk in portfolios, as can interest rate hedged and floating rate exposures.

 

Protecting portfolios from higher inflation is not just a fixed income story. For outright inflation hedges, areas to consider include real assets, such as infrastructure and real estate, which may also provide broader portfolio diversification benefits, in addition to energy-focused commodities and gold producers. Meanwhile, inflation-sensitive equity sectors which may benefit from a higher inflationary environment include financials, materials or value factor funds.

POSITIONING FOR THE UNKNOWN

Investors may be able to manage downside risk through varied, adverse conditions by building all-weather resilience into their portfolios. Resilient portfolios take measured risk accounting for uncertainty, hold diverse exposures and adapt to changing market conditions.

Explore the tabs below for implementation ideas on how to build portfolio resilience for unknown risks through equities, fixed income, and commodities.

NAVIGATE OUR RANGE

For all-weather resilience in equities, we believe defensive factors and quality sectors may provide ballast in volatile markets, and also favour exposure to beneficiaries of long-term secular growth trends, like sustainability.

Source: RQA stress test of the full iShares product suite under growth slowdown and recession scenarios, September 2018.

1. Source: Index Insights analysis of ESG exposures in varying market scenarios: Sustainable indices: built for all weather?, March 2021.

References to specific investments are for illustrative purposes only and are not intended and should not be interpreted as recommendations to purchase or sell such investments.

While the traditional role of government bonds as a source of portfolio ballast has diminished in recent years, exposure to the front end of the spectrum may still help boost resilience in risk-off markets. Investors looking to hedge against upside inflation risks may consider inflation-linked bonds.

Source: RQA stress test of the full iShares product suite under growth slowdown and recession scenarios, September 2018.

References to specific investments are for illustrative purposes only and are not intended and should not be interpreted as recommendations to purchase or sell such investments.

Gold may boost all-weather resilience as a portfolio diversifier: the precious metal has near-zero correlation over the long term to global equities and a negative correlation to rates.

Source: RQA stress test of the full iShares product suite under growth slowdown and recession scenarios, September 2018.

References to specific investments are for illustrative purposes only and are not intended and should not be interpreted as recommendations to purchase or sell such investments.