Iran conflict: diversification and portfolio resilience
By Patrick Brenner, Fund Manager - Multi-Asset Investments, and Joven Lee, Multi-asset Strategist, at Schroders
Diversification is not simply about holding different assets, but about holding assets that respond differently under pressure.
Periods of geopolitical and macro uncertainty, such as the latest events in the Middle East, reinforce a core multi-asset principle: diversification must be deliberate and forward-looking.
Building portfolios with inherent hedges – including measured exposure to commodities and avoiding excessive concentration in any single sector – can materially improve resilience. When portfolios are structured proactively, investors are often in the more advantageous position of deciding where to take profits during market stress, rather than being forced to reactively cut losses.
In recent years, traditional assumptions have been tested. Bonds have not always behaved as reliable diversifiers, particularly during inflation shocks, and the long-standing strength of the US dollar has periodically come into question.
In this environment, incorporating real assets such as gold and broader commodities can play an important stabilising role. These exposures can provide diversification benefits when markets reprice and can help portfolios navigate supply-driven shocks or renewed inflation volatility. Thoughtful allocation to real assets therefore strengthens overall portfolio robustness when traditional hedges prove less dependable.
Commodity prices rise amid supply disruptions
The current conflict is shaping up to be different from the past. Unlike last year’s brief 12-day conflict, the current situation involves broader US and Israeli strikes and a more aggressive response from Iran. This has included strikes on energy infrastructure (such as oil refineries and LNG facilities) in the region.
In addition, the Strait of Hormuz - one of the world’s most critical energy chokepoints - appears virtually closed. The strait is a narrow and highly exposed passage via which flows c.20% of global oil and LNG supplies, as well as significant amounts of fertiliser and aluminium. A prolonged disruption would therefore affect multiple commodity markets, not just crude oil1.
This is not an oil-only story, but a wider energy and commodities repricing. However, looking at WTI specifically, the c.8% rise is still a muted response and oil remains cheap.
Implications for other asset markets
Global equities and bonds have limited direct energy exposure. The table below shows that only the UK has a high weight in energy equities. It is also worth mentioning that the Middle East is a relatively small equity and fixed income benchmark constituent.
UK equities have high weighting in energy
The emerging market debt and commodities view
Abdallah Guezour, Head of Emerging Market Debt and Commodities, said: “The rapidly evolving situation is likely to sustain upward pressure on oil prices, keep geopolitical risk premia elevated, and potentially weigh on global risk appetite. Gold and commodities would likely remain supported under such a scenario.
“With regards to various emerging market (EM) economies, we take comfort in the fact that their strong balance of payments positions, achieved through the adjustments of recent years, and their low reliance on short-term foreign capital, should leave many EM countries well equipped to withstand current geopolitical dislocations.
“Most EM countries have already demonstrated this resilience by maintaining macroeconomic stability and solid market performance despite a succession of external shocks in recent years.”
The unconstrained fixed income view
James Ringer, Fund Manager, said “The escalation of geopolitical risks has come at a time when inflation pressures have been steadily easing globally. As a result, the last 12 months have seen more evidence that fixed income can act as an offset to equity market weakness. Rising energy prices could put an end to that offset in the near term.
“Some commentators are drawing parallels to the energy price spike of 2022, when Russia invaded Ukraine. As a reminder, central banks hiked aggressively in response to rising inflation and bond markets suffered a significant sell-off. We caution against drawing such parallels because the global economy is in a very different position today: supply chains have normalised, labour markets have loosened and central banks have tightened policy significantly.
“Central banks will likely look through a short-lived spike in energy and broader commodity prices. However, a prolonged conflict - which increases the likelihood of a sustained rise in oil prices - will raise concerns over inflation becoming more acutely embedded. It is this secondary effect, if inflation expectations become unanchored, that might be a concern for central banks. For now, we see some near-term upside risk to yields, but still within the recent trading range.”
“Recent events reiterate the need to actively manage fixed income portfolios, not only capture opportunities but also to protect against downside risks. As ever, diversification remains key.”
1 Read more on the commodities impact: Iran conflict and the implications for oil and other commodities