By Charu Chanana, Chief Investment Strategist
As the year-end approaches, investors often face two main temptations: chasing past performance from 2025 and assuming that 2026 will follow a similar trend. This mindset can lead to fragile portfolios, as the real risk may not be the next headline but rather the hidden bets already present in the portfolio.
A practical approach to strengthen portfolios is to conduct a mental "stress test" against plausible market shocks. This exercise helps investors identify vulnerabilities and prepare for potential market disruptions.
This scenario considers a slowdown in AI demand or a market that becomes more selective about AI investments. Key triggers include:
Vulnerable Assets: Crowded AI leaders, high-multiple growth stocks, and portfolios heavily reliant on AI.
Resilient Assets: Companies with strong cash flow and diversified exposure.
A potential increase in long-term yields by 1% could arise from renewed inflation concerns or tighter central bank policies. Key vulnerable assets include:
Resilient Assets: Cash-flow-positive equities and shorter-duration fixed income.
This scenario involves a reset of earnings expectations, leading to lower forecasts and compressed margins. Vulnerable assets include:
Resilient Assets: Companies with quality balance sheets and stable cash flows.
A rapid 5-10% movement in the USD can significantly impact returns. Vulnerable assets include:
Resilient Assets: Portfolios with diversified regional exposure.
This shock is characterized by sudden volatility spikes and widening credit spreads. Vulnerable assets include:
Resilient Assets: Cash, high-quality liquidity, and simpler portfolios.
Investors are encouraged to list their top 10 holdings and assess which shock would impact each holding the most. This exercise can reveal hidden risks within the portfolio. For example:
If a significant portion of the portfolio is exposed to the same shock, it may indicate a lack of diversification. The solution is not to sell everything but to adjust the portfolio to mitigate these risks.