Old tricks for a new risk paradigm

Has the world really become more uncertain? Are the risks for investors heightened and more widespread? Are markets really more volatile?  And if all of this is true, how should investors be thinking about it?

Well, it’s fair to say that there’s always a degree of risk and uncertainty for investors. But there’s also no denying that risk has remained elevated in recent months. From the challenges of interpreting geopolitical shifts to lingering questions around the rate-setting strategy of central banks, the only thing that’s certain is that uncertainty is everywhere you look.

According to our 2025 survey of wealth managers¹, geopolitical uncertainty comes across in a number of economic risks. An escalation of current wars in Ukraine and the Middle East is cited as a threat for 34% of those surveyed.

Then there’s the second term of US President Donald Trump. Even before Trump’s tariff tantrum in April, US-China relations (34%) ranked among the greatest economic threat for these professional investors. But the announcements made on ‘Liberation Day’ marked a new period of uncertainty for investors navigating shifting asset class dynamics. In many ways this uncertainty isn't going away – indeed, it could be seen as a new normal.

Volatility everywhere

Concerns over the potential economic threat of political volatility are echoed in what wealth managers see for portfolio risks in 2025. After the relative calm of 2024, when volatility was 35% lower than the levels experienced in 2023 and 2024, 54% of respondents globally list market volatility as a top portfolio risk this year. And while inflation and interest rates aren’t far behind, equities pose unique risks in today’s environment. Indeed, valuations are a key risk for 43% of those surveyed.

The risk in markets is getting sticker too. As Julien Dauchez, Head of Portfolio Consulting & Advisory at Natixis IM Solutions, explained: “We’re in a very different place from the investment environment we lived in from 2010 to 2020, which was characterised by lower rates, lower inflation and lower volatility. Average equity volatility is higher since 2020, the spikes in volatility are becoming more frequent, and volatility of volatility – which reflects how much the market's expectations of future volatility are changing – is also on the rise.”

Much of this is mirrored in the graph below, which charts the evolution of the CBOE Volatility Index (VIX) since 1990.

Evolution of the VIX since 1990

Source: Natixis IM Solutions and Bloomberg, 2025

Often referred to as the ‘fear gauge’, the VIX measures the market's expectation of 30-day volatility based on S&P 500 index options. It is widely used to gauge sentiment in the equity markets. A higher VIX value typically indicates greater expected volatility and is often associated with increased market uncertainty or fear. Conversely, a lower VIX value suggests a calmer market environment.

But it’s not just equity markets that are seeing heightened volatility. Spikes have been observed in the implied volatility – the market's expectations of future volatility based on option pricing – in the 10-year Treasury yield. A sudden increase in implied bond volatility may reflect a shift in investor sentiment about inflation, which usually weighs negatively on US Treasury prices.

Moreover, since the 10-year Treasury yield is closely tied to expectations about future real interest rates and economic conditions, an increase in implied volatility can signal uncertainty about the long term direction of interest rates or changes in inflation expectations. This might occur during times of economic instability.

Indeed, virtually all asset classes have been affected by rising volatility. The chart below shows the percentage change in implied volatility for gold options and the changes in the MOVE index.

Changes in the MOVE index and implied volatility for gold options

Source: Natixis IM Solutions and Bloomberg, 2025

Rising implied volatility in gold can be telling, owing to the commodity’s reputation as a safe-haven asset. Therefore, during periods of geopolitical instability or financial market turmoil, investors may flock to gold for its perceived safety, leading to higher demand for options and increased implied volatility.

Meanwhile, the MOVE index provides an estimate of the expected volatility of Treasury yields over the next month, based on the prices of options on Treasury futures. It is calculated using a weighted average of the implied volatilities of various Treasury options, making it similar in concept to the VIX Index. It is widely used by fixed income investors and traders to inform their strategies and assessments of market conditions.

Rethinking risk

So, how should investors interpret this environment of heightened volatility and how can they protect their investment portfolios? It certainly calls for some fresh approaches to portfolio construction – and a return to some traditional ways of assessing risk.

One of these approaches is ‘risk-parity rebalancing’, which aims to achieve a more balanced risk distribution among various asset classes within a portfolio, rather than focusing solely on asset allocation based on capital weights. The goal is to equalise the risk contribution from each asset class, allowing investors to maintain a diversified portfolio that can perform well across different market environments.

As an approach, it fell out of favour during the 2010s – a decade characterised by relatively low volatility in financial markets. This compression in volatility led to challenges for risk-parity strategies, which rely on volatility estimates to determine asset allocation. When volatility is low across the board, the dynamic rebalancing process can create inefficiencies, and the expected risk diversification may not materialise effectively.

Moreover, the prolonged low-interest rate environment following the 2008 financial crisis resulted in lower returns for traditional fixed-income investments, particularly government bonds. Since risk-parity strategies often allocate significant portions of capital to bonds for risk control, the reduced returns from these assets diminished the overall performance of risk-parity portfolios.

Risk-parity portfolios also experienced underperformance relative to traditional equity-heavy portfolios during the bull market of the 2010s, which led to some scrutiny and scepticism regarding their effectiveness. Investors began to seek alternative strategies that could better capture the strong returns of the equity markets and adapt to the changing landscape of risk and return.

In a risk-parity framework, the correlations between asset classes play a crucial role in determining risk allocation. During the 2010s, correlation structures changed, often leading to instances where traditional safe-haven assets, like Treasuries, did not behave as expected during market stress. This dynamic reduced the effectiveness of risk-parity strategies, as they may not have provided the desired diversification during periods of market turbulence.

Active opportunities

However, the 2020s are already proving to be a markedly different decade. Investors are once again looking to target a desired level of volatility across a diversified portfolio.

Julien thinks it could be an opportune moment for risk-parity rebalancing to prove itself as an important tool for building resilient investment portfolios.

He said: “Risk parity is a great way to harness changing correlations between - and within - asset classes, whilst also avoiding risk concentration during volatility spikes. Besides, it is possible for investors to use the risk parity framework for tactical purposes without challenging their long-term strategic asset allocation, essentially allowing them to build portfolios that are more resilient to drawdowns, or negative shocks.”

He went on to explain that it’s an approach that can be used tactically within portfolios’ main buckets – rebalancing the equity component between small and large cap, for instance, or thematic versus non-thematic, then doing the same for the fixed income component by rebalancing across global bonds, government bonds, high yield, and so on.

Yet, according to Julien, it can also make use of implied volatility for assets and strategies, allowing an adjustment in portfolios on a forward-looking basis.

He continued: “We’re constantly refining the risk-parity framework so we can help clients build more resilient portfolios at a time of heightened market risk. Our research shows that adding a small proportion of liquid alternatives or commodities to these portfolios structurally increases diversification, reduces spikes in risk, minimises drawdowns and enables faster recovery. And as active managers, we have a duty to employ active downside risk management.”

Managing risk exposure and leveraging diversification benefits using a risk-parity rebalancing approach may yet end up being one of the more durable investment approaches for the next decade.