Dubai: Clients in the Middle East have joined their overseas peers to resort to small-term hedging strategies even as market risks become idiosyncratic, triggering similar reaction from bonds and equities, resulting in a breakdown of diversification between asset classes, leading experts say.

The cost to hedge against the steepening of the yield curve (which means the longer dated securities yield more than shorter ones due to expectations of higher rates even as inflationary pressures rise) is quite low. This has attracted funds into the short-term trading or hedging strategies.

The 30-year US treasury yield saw its steepest rise since the start of the year, rising from 2.96 per cent in late August to 3.4 per cent now.

“The flows have been going in short-term opportunities. We have seen substantial flows from all centres in strategies that offer protection against yield curve steepening. Ordinarily when Fed raises rates, the yield curve flattens in a sell-off,” Vinay Pande, Global Head of Trading Strategies at UBS AG told Gulf News from New York.

“The flows have increased a lot relative to past years, as back then no one was concerned. There has been a large increase in awareness. The awareness is coming from across the board from Asia and EU elsewhere,” Pande said.

UBS has changed its hedging strategies to attune it with the stage of the market cycle.

“The big worry is at the very peak of the cycle, both bonds and stocks are prone to a sell-off, so what is the point in buying one and selling another. As the cycle matures, your approach has to evolve. We are approaching the late middle or early last stage of cycle, and this is where the risk rises to financial assets,” Pande said.

UBS is resorting to strategies such as buying a call on S&P 500 index conditional on the rate market remaining rangebound among others.

‘Striking the right balance’:

Union Bancaire Privee (UBP) has noted increasing interest in their hedging strategies.

“The number of trades and leads is increasing quite quickly. We think this pace should continue in the short term,” Philippe Henry, Global Head of Cross-Asset Solutions at UBP, told Gulf News. Our group is essentially focusing on strategic and systematic hedges as opposed to tactical, opportunistic ones,” Henry said.

“When designing our hedging strategies, we want to strike the right balance between minimising the cost of holding the hedge and maximising its responsiveness when market stress arises,” Henry said.

In all, the basic idea is to protect your portfolio. “If you have an allocation to liquid alternatives like long-short equities, you are still getting access to some of that growth, but if you see a downturn you have an element of downside protection,” Chris Dawe, product manager at Schroders said.