01. What are hedging assets? Hedging motives and asset types.
Hedging assets refer to assets that can maintain stable intrinsic value during significant fluctuations of other assets.
Hedging assets have two basic characteristics: one is anti-drawdown, and the other is high credit.
Anti-drawdown means that during a widespread decline in asset prices, hedging assets need to decline less.
Hedging means to minimize losses as much as possible.
High credit means that only high credit can possess high liquidity, allowing for stable pricing advantages when other major assets are devalued. This is also the source of the hedging asset value's 'anti-drawdown'.
There are generally three layers of risk scenarios, and different types of hedging assets perform differently in these three scenarios.
The first layer of risk scenario is economic recession risk (deflation scenario, declining demand + liquidity easing).
The second layer of risk scenario is political order conflict (stagflation scenario, declining demand + supply constraints + liquidity tightening).
The third layer of risk scenario is financial order reconstruction (the status of world currency is challenged, declining demand + monetary dilemma).
02. First type of hedging scenario, typical deflation scenario (monetary easing + declining demand).
① General rule: In the ranking of hedging assets, bonds are optimal, currency and gold belong in this category, while commodities are the weakest.
② One structural rule: In a deflationary process, the country with greater monetary easing will have better relative bond yields; the opposite currency will be relatively weak. For example, in 2001, Japan experienced more severe deflation with more significant monetary easing, resulting in Japanese bonds being significantly better; the yen underperformed. In 2008, the U.S. was the initiator of the global financial crisis, with substantial monetary easing, making U.S. bonds relatively superior, while the dollar underperformed.
③ Another structural rule: Assets that can reflect growth potential do not perform too poorly during deflation, while assets related to the source of deflation perform worse. For example, the internet bubble in 2001 increased Japan's deflationary pressure, leading to weak performance in Japanese stocks and the yen. In 2001, the potential momentum in the U.S. real estate market was strong, making U.S. REITs perform optimally. Conversely, during the 2008 global financial crisis that originated from the U.S. subprime crisis, U.S. REITs performed the worst during that deflationary process.
03. Second type of hedging scenario, typical stagflation scenario (monetary tightening + declining demand + supply contraction).
① General rule: In the ranking of hedging assets, commodities and gold are optimal, currency is second, and bonds are the weakest.
② One structural rule: During stagflation, different countries have different underlying development potentials. Countries with stronger development potential can have stronger currencies. For example, in 1973-1974, Japan was in a vigorous development phase, so the yen was significantly better than the pound and dollar at that time. In 2022, due to fiscal expansion and technology capital expenditure, the U.S. economy was outstanding, making the dollar significantly better than other currencies.
04. Third type of hedging scenario, global financial order restructuring (monetary dilemma + declining demand).
① General rule: In the ranking of hedging assets, gold is optimal, while commodities and world currencies perform the weakest.
② One structural rule: During periods of financial order reconstruction, gold is the most certain asset. Meanwhile, the world currency, which serves as the anchor of the financial order, performs the weakest. During the process of financial order reconstruction, global demand is suppressed, leading to weak performance in commodities.
③ Another structural rule: During periods of financial order reconstruction, a type of currency outside the world currency is seen as a substitute for the world currency and often performs well. For example, in the 1929-1930s, the pound depreciated while the dollar appreciated relative to the pound. In 1961, during the dollar crisis, the yen appreciated relative to the dollar.
05. Why can bonds serve as hedging assets?
Bond prices fluctuate with interest rates; therefore, bonds are not without risk. The main reasons for labeling bonds as hedging assets are as follows:
Inherent fixed income: This characteristic leads to relatively low risk, making it suitable for low-risk investors or hedging investors.
Their price fluctuations and economic cycles: Other major asset classes show weak or negative correlations, helping to diversify risk.
Firstly, traditional bond assets are also known as fixed income, meaning that holders will receive a 'fixed' amount of repayment at 'fixed' times.
Although bond prices will change with fluctuations in interest rates, if you hold the bond until maturity without considering reinvestment of interest, the total income you receive at maturity is fixed, and the primary risk you face is default risk (for long-term bonds, also consider inflation risk).
In the case of holding until maturity, regardless of whether the economy is good or bad, your investment returns are generally guaranteed, which is why bonds are often said to be relatively low-risk investment products, thus becoming a hedging tool in the eyes of 'risk-averse' individuals.
Secondly, since the 1990s, as people's understanding of financial products deepened, bond yields and stock yields began to show a noticeable divergence. Bond yields and stock yields demonstrate a relatively clear weak or even negative correlation.
This means that when the stock/crypto market is unstable and declining, bond prices may instead remain stable or even rise.
Therefore, for most stock/crypto investors, bond assets serve as an effective risk-diversifying 'hedging' tool.