Feature – Geopolitics
In most asset classes, LPPI tend to skew towards the quality end of things, Tomlinson says, and seek to minimise un- rewarded risks. “We do have some exposure to emerging mar- kets but it is small. In my opinion, governance, legal and mis- appropriation
risks are frequently
underestimated when
looking outside developed markets. “That’s not to say you cannot invest successfully, but you need a different playbook and specific local expertise,” he adds. “Due to this, our portfolio is pretty well positioned at present if we do move into a splintered world but we are always challenging our thinking and assumptions.” Tomlinson does though come back with a more cautious sce- nario envisaging a disruption when taking a more medium- term view. “There is a real risk that the next decade or two could look very different to the period where most investors today have been managing money. “Not many of us were investing pre-Volcker. I was about to start primary school when he took the helm at the Fed.” Expanding on this further, Tomlinson says the disruption is a real and potentially serious proposition. “The implications could be significant over the next decade,” he says. “We are clearly moving from a globalised world where most major play- ers ‘play nice’ to one of reduced trust and lower co-operation.” This will naturally have its own negative ramifications. “De- globalisation and building additional redundancy into supply chains will likely be inflationary. It’s now about security of sup- ply and not just driving costs to the lowest level,” Tomlinson says. “Increased geopolitical tensions are likely to lead to higher average risk premia, so all else equal, this will mean lower asset values.”
A new regime For Emily Haisley, managing director of risk and quantitative analysis at Blackrock, geopolitical disruption is also real, prob- lematic and one in which investors need to be aware. “A new regime is taking hold,” is how she describes it, “but we do not see this yet reflected in the pricing of stocks and bonds.” Interestingly, Haisley puts the focus on developed markets and the Western bloc. “We have cut developed market equities to underweight. We see an increasing risk of the Fed overtighten- ing, expect growth to stall and see earnings estimates as overly optimistic.” This presents quite a list for investors. In addition, heightened volatility often creates greater market mispricing, therefore investors need to be on their guard, Hais- ley says. “The new regime requires being nimble and using frequent tactical changes.”
Derrick Irwin, portfolio manager at Allspring Global Invest- ments, says there is a balance between different bloc markets that need to be identified. “It is likely that correlations between emerging and developed markets will continue to fall, adding to
24 | portfolio institutional | October 2022 | Issue 117
We are clearly moving from a globalised world where most major players ‘play nice’ to one of reduced trust
and lower co-operation. Richard Tomlinson, Local Pensions Partnership Investments
the diversification benefit of emerging market assets for global investors,” he says. “Diversification will be critical as the down- side from asymmetrical risks – such as a conflict over Taiwan – will be significant for emerging and developed markets.”
Security spending
An interesting development in the shifting geopolitical picture means national and regional security concerns could well drive significant outward investment – the decision by the United States to build a new military base in Poland is a noteworthy example. “Geopolitical competition is often a driver of government spending on innovation, as numerous examples from the Cold War attest. Re-orientation of supply chains – ‘friendshoring’ as former Fed chair Janet Yellen described it – will create new eco- nomic hubs,” Irwin says. “For example, trade between the US and Mexico has been growing faster than trade between the US and China since 2018, and we expect this to accelerate.” The emerging market picture is bound to change, as they will be central to the competing bloc scenario. “The investment landscape in emerging markets is changing, and it will be crit- ical for institutional investors to understand which companies will be winners and losers as the playing field shifts,” Irwin says. But there are also positive effects. “Opportunities will also emerge, particularly in emerging markets,” Irwin says. “The battle for secure supplies of commodities will likely lead to greater investment by China and the West in key commodity producing countries, particularly in the emerging world.” This suggests a competing bloc picture could well be more nuanced and not so easily divided into pure dogmatic blocs. At
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