No such thing as a perfect hedge

Last week markets were once again shocked by the higher-than-expected inflation rate for June. With 9.1 percent YoY, we are back at levels we have not seen since the beginning of the 1980s, and Fed chair Jerome Powell is becoming more hawkish with every day that passes. 

As there is no longer any doubt inflation is not transitory, investors seek protection in alternative assets, only to find that usually, non-correlated assets are now falling steadily together in an almost perfect waltz. The problem, however, is that while combining non-correlated assets and strategies over time tends to generate high risk-adjusted returns, there is no such thing as a perfect short-term hedge against inflation or market downturns as correlation tends to rise during major market events (Bookstaber 1997).

If you, like many others, are experiencing it is more challenging than usual to dodge drawdowns, drastic changes in correlations might be the explanation. However, this change is normal and to be expected. And as an investor, it is essential to zoom out and remember that the perfect hedge does not exist but that inflation hedges, in particular, are measured not over months, quarters, or even years but over decades.