One of the key themes from our 2026 Outlook – fragmentation – is already playing out in a big way. Three months into 2026, we already saw U.S. military action in Venezuela to remove its leader, bids to take over Greenland, and a massive escalation of conflict in Iran which is engulfing the Middle East – which is causing one of the most significant oil disruptions in history. Tariffs – a big driver of uncertainty last year – are also being reconfigured amid legal challenges, while fiscal support for strategic industries continue to ramp up as various economies seek dominance and resilience in key technologies and resources. Amid a myriad of geopolitical risks, how can investors position for the age of fragmentation?
One way to think about a game plan for investing in the age of fragmentation is “offense” and “defense”. Investors can play offense by owning the beneficiaries of fragmentation, while playing defense through hedging against the risks of fragmentation, all while owning a diversified core portfolio to weather through different macro and market environments.
We covered how investors can play “offense” in the first paper in this series. In this note, we cover the “defense” part of the playbook, detailing how investors can play “defense” through diversification and hedging against downside risks (through fixed income, gold and alternatives). In a future note, we plan to highlight specific risks and opportunities in the Asia region.
There has been a dramatic repricing in front-end rate expectations since the Iran conflict began due to the spike in energy prices and short-term inflation expectations. Markets moved from pricing around two-and-a-half cuts for the Fed in 2026 to largely expecting a hold, while the adjustments for other central banks are more drastic, with multiple hikes expected for the Eurozone, the UK and Australia. We have shifted our outlook from expecting one cut from the Fed to no cuts for the year, but we still see this near-term repricing as being overdone. Rates could retrace back lower, especially as economic growth risks become greater in the event that oil disruptions persist or worsen. This outcome may necessitate eventual rate cuts from central banks, which would in turn support returns in high-quality fixed income.
Short-dated investment grade bonds offer a tactical opportunity for investors to step out of cash. This asset class offers stable portfolio returns in multiple scenarios: a benign case where oil prices normalize in a matter of months, and in a downside growth situation where the Fed may respond with rate cuts. Unconstrained fixed income managers can also identify attractive opportunities globally and across the curve, especially in an environment of fast-changing market narratives and mispricings.
Gold – traditionally expected to perform in times of geopolitical crisis – has not acted as a clean near-term hedge throughout this period of market volatility. However, this is typical in fast-moving geopolitical shocks where liquidity needs and rising real rates drive negative price action, like in 2022. This is consistent with our view that gold is better framed as a diversifier than a reliable, point-in-time “risk-off” hedge during fast geopolitical shocks or deleveraging episodes. In these windows, USD strength, rising real rates, and technical liquidity dynamics (including profit-taking) can dominate near-term price action. Some commentary has suggested reserve managers may be slowing purchases – or even outright selling gold – to raise liquidity amid weaker currencies and higher near-term funding needs (energy import bills, defense needs, and/or FX intervention). We haven’t seen direct evidence of outright central bank selling, though at a minimum the pace of buying may be moderating at the margin.
We have adjusted our outlook for gold prices moderately lower for this year, but we continue to see upside from current levels. Our longer-term case for gold remains intact: we continue to see official-sector diversification away from USD concentration as an important pillar, and we view gold as a useful portfolio diversifier and store of value in a more fragmented global economy, particularly as a hedge to regime risks (fiscal and debt dynamics, sanctions and capital restrictions). The ongoing conflict would likely serve to heighten these risks in the long-term. The recent selloff presents an opportunity for long-term investors to add strategic exposure, or monetize its high volatility through structured products.
Investors into equities and credit are right. Despite the selloff in markets since the conflict began, equity market concentration remains near all-time highs amid elevated valuations. Credit spreads are also near multi-year tights. Energy shocks, economic nationalism and fiscal activism have reignited risks of inflation and interest rate volatility, making positive stock-bond correlation more likely. That means the old diversification playbook isn’t as reliable as it used to be – the traditional 60/40 portfolio is less likely to provide the historical stability that investors sought to grow their wealth across market cycles.
Building a resilient portfolio today means going beyond traditional equities and bonds, and leaning into less-correlated, differentiated return streams is critical. While high-quality fixed income remains a useful hedge against economic growth risks, investors need to “diversify the diversifiers” and manage the various other risks arising from the age of fragmentation. That’s where alternative investments come in. Many investors may treat alternatives as a tactical portfolio add-on, but we believe they’re a strategic necessity for resilient portfolios. Asset classes such as hedge funds and infrastructure can help protect against the risk of equity market concentration and higher likelihood of positive stock-bond correlations. Careful manager selection is critical as dispersion widens.
The hedge fund universe is broad, but specific types of hedge fund strategies can be used as a tool for diversification in portfolios. Some hedge funds may reduce portfolio volatility by using various trading strategies and accessing niche exposures that may generate return streams uncorrelated with the broader market, which may help to mitigate drawdowns in times of market stress. Therefore, hedge funds may help a portfolio to compound more efficiently in the long-term by limiting downside losses, especially in times when both stocks and bonds failed to deliver consistent returns, like in 2022. Macro hedge funds in particular have been a critical diversifier – negatively correlated to both tech stocks and the 60/40 portfolio while also providing positive returns during major market drawdowns.
We expect this pattern to continue, given prevailing conditions of elevated rates, volatility and performance dispersion by sectors and assets that create more chances for hedge fund managers to find opportunities in mispricings. Importantly, hedge funds can give investors the opportunity to diversify without sacrificing absolute returns.
Real assets such as infrastructure can act as powerful portfolio diversifiers. This asset class stands out with several factors underpinning its attractiveness to investors. It has a higher yield level over most categories of fixed income. Infrastructure returns have also been historically stable during market regimes with higher inflation. This is a result of core infrastructure assets being backed by multi-year contracted cashflows, with many of these assets offering exposure to essential services with resilient demand and inflation-linked revenue. Furthermore, this investment theme is supported by a long-term trend: resilient infrastructure is now a matter of national security, and large amounts of public and private capital are being put to work to enhance, upgrade and expand these projects.
Geopolitical tensions are causing heightened volatility in markets and reducing the effectiveness of traditional portfolio hedges. In order to build resilient portfolios for achieving long-term investment goals, investors need to understand the importance of long-term strategic asset allocation and incorporate asset classes which can hedge against the risks of fragmentation, and provide uncorrelated and stable return streams across various macro and market regimes. High quality fixed income can provide yield and hedge against downside growth risks. Gold can hedge against the risks of dollar concentration and fiscal concerns. Hedge funds and infrastructure can provide stable returns even in times of elevated inflation and stock-bond correlations.
Reach out to your J.P. Morgan team for advice how they can fit into your portfolio.
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