Portfolio Optimization in a Higher-for-Longer Interest Rates Environment

While major developed economies seem to be headed towards recession, global inflation dampens but central banks believe that upside risks remain strong and signal for higher-for-longer interest rates. The higher-rate regime will be one of the main characters in the portfolio allocation stories for the next year.

Investors across all asset classes face a highly uncertain macroeconomic environment. This report elaborates a macro-based equity portfolio optimization strategy to help investors navigate the current uncertainty.

We provide an overview of the current macroeconomic context surveying the most relevant data. This gives us a useful snapshot to be kept in mind for the following asset classes analysis. We scrutinize how the higher-for- longer central banks narrative and of the market expectations about future macroeconomic developments impacts the performance of several asset classes. This analysis encompasses fixed income, considering both government and corporate bonds; equities, conducting comparisons by sector, by type of stock (growth vs value) and by company size; alternatives, including ETFs, commodities, real estate and private equity.

We then conduct a quantitative analysis aimed at recommending an equity portfolio strategy to endure the current macroeconomic volatility. After a macro-based stock selection, we construct a mean-variance and a risk-parity portfolio. Finally, we conclude that a risk-parity strategy might be more fit, effectively distributing investments among diverse assets and reducing risks specific to particular sectors.