Geopolitical tensions have been on the rise over the past few years, with the growing rivalry between the USA and China, the Russia-Ukraine war and just this week the Israel-Hamas war causing concerns in markets.
This has led to the view that the ‘peace dividend’ investors had been enjoying since the end of the Cold War is now over.
Where investors allocate their capital may also become more important, as was evidenced by the freezing of Russian assets following the country’s invasion of Ukraine.
Geopolitical risk, which refers to how global political events impact economies and financial assets, may become more important in how investors build their portfolio.
Trustnet has asked wealth managers what the biggest geopolitical risks of our time are from an investor’s perspective.
US-China relations
The rivalry between the USA and China is arguably the highest on the list as it engulfs the two largest economies of the world. They are also the largest constituents of major indices, with America accounting for 69.7% of the MSCI World and China for 30% of the MSCI Emerging Markets index.
For comparison, Russia made up less than 4% of MSCI Emerging Markets in early 2022 prior to its exclusion from the index.
Yet, wealth managers do not believe the tensions between the two superpower makes China uninvestable.
Jasper Thornton‑Boelman, investment director at Parmenion, said trying to tweak a portfolio around the edges to avoid the negativity of the deteriorating US-China relations would be a futile exercise.
He said: “They are both of such importance within the global economy, that any fall outs impact every asset class. As with everything, you need to ensure you’re being compensated for the risks being taken.”
Rather than making any call on China, Parmenion prefers using broad emerging markets funds to delegate country exposure decisions to the underlying managers.
Another cause for concern is the idea that China could follow Russia’s lead and invade Taiwan, but Chris Metcalfe, chief investment officer at IBOSS, said this was unlikely.
“In our opinion, the events of Russia's invasion make an invasion less likely. Not even the most ardent Vladimir Putin supporter could possibly say that the invasion has been a success and even less blueprint for any other country to invade its neighbours,” he said.
War across the world
Along with the ongoing Russia-Ukraine conflict, this week tensions between Israel and Palestine turned to war. Kristina Hooper, chief global market strategist at Invesco, warned that the conflict between Israel and Hamas could have wider implications for the rest of the region.
She said: “Part of the Israel-Saudi peace deal was a pre-condition of Israeli concessions to Palestinians. This seems unlikely to happen in the current environment, which suggests the peace deal may be derailed.
“The Wall Street Journal has reported that Iran was involved in Hamas’ attack; if this is confirmed, that risks other countries being pulled into the conflict.”
Vincent Mortier, chief investment officer at Amundi, and Anna Rosenberg, head of geopolitics at the Amundi Research Institute, added that the US as well as other Western countries could temporarily shift focus away from Ukraine in terms of military aid.
They also believe that the war could lead to higher oil prices as the region is home to many of the world’s leading oil producing countries.
Elections
A rising oil price would be negative for incumbent US president Joe Biden in an election year, which could be critical for many major markets.
Metcalfe said the potential re-election of Donald Trump in the US – and the way it may affect multiple geopolitical concerns – was a risk worth considering.
He said: “Individual countries appear to be prepared in some small ways, but if Trump is re-elected despite being impeached twice and facing multiple criminal charges, then it's impossible to say how belligerently he will act and what the outcome will be.
“A Trump potential re-election is a good example of an event which would cause huge upheaval but which little can be assumed in terms of outcome. The result is that we are aware of the potential chaos his election would cause, but it’s a case of ‘keep calm and carry on’.”
However, it is not just the US that has elections upcoming over the next 14-18 months, with others of note including the UK, India and Taiwan.
John Moore, senior investment manager at RBC Brewin Dolphin, warned that potential risks are yet to be priced in, but might develop during this period.
The end of globalisation
For Tom Harrison, partner at Saltus, the main geopolitical risk of our times was the effects of deglobalisation and the removal of global supply chains.
He said: “Whilst ‘reshoring’ or ‘friendshoring’ has its benefits from an economic control side, the stifling of global growth and the potential increased costs to consumers could increase the long-term inflationary dynamic that is now playing out.”
How important are geopolitical risks in portfolio construction?
Given the new paradigm and the ensuing risks, investors may ask themselves whether geopolitics is a factor they should give more consideration when building their portfolio.
Metcalfe said: “It's important to make sure that any knowable geopolitical event has only a limited impact on a portfolio if it comes to pass.
“Putin's invasion of Russia is a good example of this. The case for Russian assets looked quite strong pre-invasion but then collapsed completely. Knowing the amounts you have invested in a country all of a sudden becomes very important when things go wrong.”
While not dismissing geopolitical risk, Moore added that geopolitical risk should be factored in among others, such as valuation risk, rating risk or execution risk, when building a portfolio.
He added: “It is also worth bearing in mind that investment is a risk game and therefore one has to think about what might be priced in and what their tolerance is both individually and collectively.”
Yet Thornton‑Boelman does not see geopolitical risk as an important factor in portfolio building.
He said: “You absolutely may need to take something into account on an ad-hoc basis but the nature of geopolitics is that positioning a portfolio to hedge a risk can be quite hard.
“Getting both the outcome and the market reaction right is tricky. Binary votes or decisions made by (often) irrational leaders are just not something you can forecast with much confidence.“