Hedging Macro Risk in Equity Portfolios

Over the past five years, investor concerns around yield volatility and inflation risk have intensified, fueled first by COVID-19-era supply disruptions and the subsequent aggressive monetary stimulus and, more recently, by escalating trade tensions. Traditional equity portfolio analytics, which typically emphasize style-factor and industry drivers, often underplay these important macro exposures. 

Today’s CIOs, portfolio managers and risk teams, however, need a more effective means to quickly and systematically identify, measure and manage macro risks such as interest-rate sensitivity and inflation. We outline one way to do so. 

We calculated an interest-rate-sensitivity (IRS) factor to evaluate how equity returns responded to changes in interest rates. Specifically, we  regressed the beta-adjusted residual return on the return of the 10-year benchmark rate for each of the 77,000+ stock included within FactorLab.¹ Using a rolling five-year window, we capture how these sensitivities have evolved over time. A positive IRS exposure indicates that a stock is more vulnerable to rising yields than the average stock in the universe.

To understand the performance implications, we first sorted stocks in the MSCI USA Investable Market Index (IMI) universe into quintiles based on IRS exposure to changes in the 10-year U.S. Treasury yield. We also grouped months over the past almost-15 years into quintiles based on the magnitude of yield changes.² Analyzing average excess returns for each combination of stocks-month quintiles revealed a clear pattern: During months with the steepest rate increases, high-IRS-exposure stocks underperformed sharply relative to low-exposure stocks; conversely, during months of falling rates, these stocks outperformed. This directional relationship held across other regions such as Europe and Japan, when using their respective local 10-year government-bond yields. 

Similarly, we observed the same pattern for inflation sensitivity in both the U.S. and Europe. During periods of rising inflation, on average, stocks with higher inflation sensitivity underperformed stocks with lower sensitivity and vice versa.³

Hypothetical quintile portfolios were formed each month by sorting the constituents of the MSCI country or region IMI based on their standardized sensitivity to the 10-year local-currency interest rate or 10-year breakeven inflation. Both the rate (or inflation) changes and the returns of these portfolios were tracked over the following month. Quintile portfolio returns are computed using square-root market-cap-weighted excess returns. The analysis period spans from January 2011 for USD and EUR interest-rate and inflation sensitivities, and January 2012 for JPY interest-rate sensitivity, through May 2025. 

Mapping macro exposures for familiar market segments can help clarify where risk may be concentrated. Based on our metrics, the financial and energy sectors tended to benefit when yields rose, while real estate and utilities, which have typically generated stable, bond-like cash flows, outperformed when rates fell. These sector patterns were broadly similar to those observed for inflation sensitivities.  

The analysis period spans from January 2011 through May 2025. Boxplots show time-series distribution of end-of-month index-weighted (standardized) exposures. Whiskers show 5th and 95th percentiles. 

Applying this same focus on interest-rate sensitivity to MSCI factor and style indexes revealed notable trends. Value persistently had a “shorter duration” (lower exposure to interest rate risk) while growth and minimum volatility had longer durations. Minimum volatility’s large positive IRS exposure likely stemmed from its tilt toward defensive stocks and bond-like characteristics. Momentum and high dividend yield exhibited the most variable exposures over time, reflecting shifts in underlying stock selection and sector composition — a natural outcome of their rules-based construction. 

The analysis period spans from January 2011 through May 2025. Boxplots show time-series distribution of end-of-month index-weighted (standardized) exposures. Whiskers show 5th and 95th percentiles. The indexes used are the MSCI USA Minimum Volatility, MSCI USA High Dividend Yield, MSCI USA Momentum, MSCI USA Growth, MSCI USA Quality, MSCI USA Low Size and MSCI USA Value Indexes 

We applied these insights to the MSCI USA Growth Index, a proxy for a growth strategy that is often characterized by longer-duration cash flows and higher interest-rate exposure. Between January 2022 and late 2023, U.S. 10-year yields rose from 1.5% to 5%, exerting pressure on rate-sensitive assets. During this period, which represents the largest secular rise in interest rates since 2011, the MSCI USA Growth Index had positive IRS exposure, making it vulnerable to rising yields.⁴

To reduce this macro sensitivity, we constructed a hypothetical optimized portfolio that closely tracks the MSCI USA Growth Index but constrained its interest-rate exposure within a narrow range (+/− 0.1 z-score), as well as its active positions and annual turnover.⁵

The analysis period spans from December 2021 through May 2025 for 10-year USD interest-rate sensitivity.   

This approach improved performance while reducing macro vulnerability — a relevant application for investors seeking to hold growth allocations through a high-interest-rate regime. Most of the performance improvements came through stock selection. 

The analysis period spans from December 2021 through May 2025 for 10-year USD interest rate sensitivity.  The blue line traces the performance of the hypothetical optimized growth strategy relative to MSCI USA Growth Index. Performance attribution using the MSCI USSLOW model.  

Macro considerations have once again become important for equity investors. Incorporating interest-rate sensitivity and other macro factors alongside traditional style and industry exposures enables investors to move toward a more holistic understanding of risk. This broader lens can support more effective portfolio diagnostics as well as help investors enhance their portfolios’ resilience to macro volatility.