The Future of Asset Allocation: The Rise of Inflation Hedging and Human Capital Hedging, Increasing Macroeconomic Importance

In the current gradual recovery of the global economy after the impact of the COVID-19 pandemic, inflation has become a focus of attention for central banks and investors worldwide. Geopolitical tensions, supply chain disruptions, and fluctuations in energy prices together weave a complex and ever-changing economic landscape.

On April 29th, Citibank's Dirk Wille analysis team released a research report, providing insights into how to adjust and optimize asset allocation in the current uncertain economic environment to address potential risks of inflation and deflation.

The report introduced a new 60/20/20 asset allocation model, challenging the traditional 60/40 stock-bond ratio, and emphasized the importance of inflation hedging. Additionally, the report explored the potential of asset categories such as bonds and artificial intelligence.

Reducing Sovereign Debt Weight

The report pointed out that as government debt issuance continues to grow, the risks of debt default, inflation, and financial policy tightening are also increasing.

Citibank is optimistic about the stock market, believing that strong stock prices are driving market capitalization higher, allowing investors to gain more returns from improving corporate profit stories.

Therefore, the report suggests that in the medium term, stocks outperform government bonds, with the former even serving as a hedge against the latter.

AI Investment as a Hedge against Human Capital

The report stated that artificial intelligence poses a threat to the labor market. According to data from the International Monetary Fund (IMF), 60% of jobs in developed economies will be affected by AI, with half of the impact being negative.

Therefore, the report pointed out that AI poses a risk to many human capital in the labor market, and with the trend of declining human capital as people age, investment themes centered around AI can serve as a hedge against human capital.

Similar to investing in Amazon for book distributors, many white-collar workers may hedge against the risk of being replaced by investing in AI themes.

The Importance of Macro Hedge Funds

Macro hedge fund strategies are an asset class that is more likely to benefit from inflation volatility and subsequently fixed income volatility.

The report found that macro funds perform well when inflation volatility rises or falls significantly from high levels, while they perform poorly when inflation volatility is low or declining.

This situation occurred in 2012 and 2020. The reason is that an important strategy of macro hedge funds is to take positions at the short end of the relevant interest rate curve, with their Sharpe ratio (reflecting the risk-adjusted return indicator) often higher than the long end As a result, unstable inflation leads to more proactive policy making, increasing profit opportunities for macro strategies.

Citi pointed out that due to the possibility of inflation shocks being more asymmetric than in the past (most past shocks were deflationary), it is expected that inflation volatility will remain relatively high. Therefore, macro hedge funds will become an important component of asset allocation.

60/20/20 Asset Allocation Model

Citi also proposed a new asset allocation model in the report, transforming the traditional 60/40 portfolio into 60/20/20.

The report states that the traditional investment portfolio model, which allocates 60% of assets to stocks and 40% to bonds, mainly hedges against deflationary risks. However, considering the possibility of both future inflation and deflation shocks, portfolios should choose more inflation hedging tools, such as trend tracking and momentum strategies, while reducing the proportion of bonds