What Is Hedging and Should You Use It to Protect Your Investments?
Written by Boring Money
20 May, 2026
Spreading your money across different investments helps, but does it go far enough? Hedging means taking deliberate steps to protect your portfolio against specific risks, from stock market falls to currency swings and inflation shocks. Here's what the main hedging strategies are, how they work, and whether the cost of using them is worth it.
Many investors will be comfortable with the idea that they need balance in their portfolios. No one has perfect foresight, and it makes sense not to have the investment equivalent of all your casino chips on red. While spreading your investments across a range of sectors, regions, and asset classes can help, should investors also be hedging against specific risks to create stability?
For most people, their primary goal for a hedging strategy is to manage stock market volatility
. For this, their starting point will often be to blend bonds and equities. This works on the premise that bonds will tend to do well when economic growth is lacklustre and there are deflationary pressures, while stock markets do well when economic growth is buoyant and inflation is higher. This smooths out volatility over time.However, this is an imperfect solution. The relationship between stock and bond markets has changed in recent years, and they have tended to correlate more during market shocks. The IMF said in a recent paper:
The classic diversification between stocks and bonds worked historically because they moved in opposite directions. When stocks fell, investors sought safety in bonds. Bonds rallied, cushioning losses and stabilising portfolios.
“Since the start of the pandemic period—with supply shocks that fuelled inflation—bonds have become less effective in cushioning volatility in stocks. Instead of offsetting equity risk, bonds are increasingly moving in tandem with stocks. This shift is particularly pronounced during sharp market selloffs.[1]
This was seen in 2022, when the MSCI World index fell 17.7%[2] and the average IA Sterling Corporate bond fund
was down 16.1%. It has also been seen this year, when bonds have done little to cushion investors against market volatility. While holding bonds and equities can still be useful, investors may need a more nuanced approach.Can You Use Derivatives to Protect Against a Stock Market Fall?
There are specific instruments investors can use to protect against declines in the stock market. Many of the major platforms enable investors to use put options
. These hedge against falling stock prices. Investors can also use short ETFs, commonly known as inverse ETFs, which use derivatives or short-selling to deliver a rise in value when their underlying benchmark falls – the MSCI World, for example, or the S&P 500.This strategy comes with significant drawbacks: the cost of options premiums, particularly in times of market volatility, can be prohibitively expensive. Moreover, the protection is temporary and can erode quickly as the option’s time value decays.
There are also asymmetric risks involved in short-selling: share prices can theoretically rise indefinitely, but they can only fall to zero. Short-selling can result in significant losses for the unwary. It is generally a short-term solution, used to manage volatility rather than unwinding a portfolio.
Which Types of Equities Hold Up Best When Markets Are Volatile?
Lacroix points out that buying different types of equities can be an alternative option to hedging stock market risk:
As market volatility increases, the quality risk factor typically provides positive return, suggesting that stocks with high-quality characteristics tend to hold up better when the broader market faces turmoil.
An investor could buy an active manager
that focuses on quality, such as the global equity income funds from Troy, Evenlode, or Guinness, or an ETF focused on a quality index, such as the iShares Edge MSCI World Quality Factor UCITS ETF or the WisdomTree Global Quality Dividend Growth ETF.Selecting specific sectors can also help protect against specific risks. For example, the main option to protect a portfolio through an energy shock is commodities exposure. In 2022, for example, three equity sectors delivered a positive return: commodities and natural resources, and Latin American equities, which are commodity-focused, plus infrastructure. David Coombs, head of the multi-asset team at Rathbones, maintains a strategic exposure to oil stocks for this reason.
Should You Hedge Against Currency Risk in Your Portfolio?
Currencies are another area where investors often employ hedging. The historic assumption used to be that investors shouldn’t have their long-term liabilities in a different currency from their investments. In other words, if you want to take your pension in pounds, don’t load up on Dollar or Euro-based assets. However, as companies have become global and the US has been such a strong engine of stock market growth, this ‘home bias’ view has looked a little tired.
Nevertheless, it is still worth factoring currency into your considerations. For example, last year, the weakening Dollar was a significant problem. A Dollar-based investor in the MSCI World index would have seen a return of 21.6%[2]. That dropped to 13.22% for a sterling-based investor[3]. In previous years, the Dollar’s strength would have worked to a UK investor’s advantage and there are many who argue that it all evens out in the end. Nevertheless, if investors are worried, they can look at hedged versions of their investments. Most ETFs offer this – the iShares MSCI World ETF, for example, comes in a GBP hedged version. Some active funds also offer this.
That said, currencies are very difficult to predict, and can be expensive to hedge. As a result, most wealth managers employ a selective approach to currency hedging. J.P. Morgan Private Bank, for example, says its approach is to ask the question, “Is the cost of hedging outweighed by the volatility-dampening and diversification effects, so that the risk-adjusted return of the portfolio is improved?” Its analysis suggests that it can be worth hedging fixed income
investments, while leaving international equity exposure unhedged.Is Gold a Reliable Safe Haven When Markets Are in Trouble?
Gold and silver were a good hedge against geopolitical volatility for much of 2025. However, they have not proved as strong a hedge against this year’s energy and inflation shock. This is partly because they don’t pay an income, and therefore the opportunity cost of holding them is higher when interest rates are expected to rise. The rise in bond yields stalled the rally.
The reaction of gold to an actual crisis in the form of the Iran War has been quite disappointing. So, it was negatively correlated on a daily basis with the oil price and positively correlated with the Nasdaq. At least in the short term, it had become a risk on asset. Some of this may have been a general scramble for liquidity in difficult times. But nevertheless, it called into question the motive for holding gold.
He points out that the 2-year inflation-linked gilt has held its value despite sharp increases to short-term interest rate expectations.
Industrial metals have been a better safe haven if investors are worried about inflation because they are the cause of the inflation.
That said, gold may still have a claim as a hedge against crises. If investors believe that there are imminent threats to the global financial system or economy, gold tends to be the investment of choice.
Gold can be good when you have stagflation, because people start to fear for the value of their holdings versus their liabilities.
Coombs says there is no such thing as a perfect safe haven, only assets that work well in different scenarios. There is a hedge for most risks, but there will be costs attached, and investors need to decide whether they are worth paying. Volatility is the price investors pay for higher returns and investors don’t necessarily need to get rid of it.
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[1] IMF
[2] MSCI
[3] MSCI world GBP
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