Geopolitics – Feature
Investment Institute, says the situation demands more fre- quent portfolio changes by balancing views on risk appetite with estimates of how markets are pricing in economic dam- age. “It also calls for taking more granular views by focusing on sectors, regions and sub-asset classes, rather than on broad exposures,” she says.
Although, as many commentators have observed with recent market shifts, it is hard to assess the degree to which geopolit- ical risks are priced into the market.
Long-term risk Acknowledging the importance of the issue, Mikulskis observes that geopolitical risk is something investors will need to adjust to going forward. “One important thing to remember is that over the long term, living with risk and uncertainty is key to long-term investment growth,” he says. But Mikulskis adds a slightly different take. “In general, hedg- ing risks, particularly broad and high profile ones like geopolit- ical risk, usually comes with specific cost in terms of lower returns. Many geopolitical risks have loomed large over the past decade while global stocks have overall delivered great returns.”
In addition, geopolitical risk is difficult to sometimes fully assess based on three counts: it is difficult to forecast in terms of an overall outcome; timing; and the investment market out- come. “You need to get all three of those right,” Mikulskis says. “And it’s possible to get two out of three right, but still lose money,” he adds, highlighting the challenge for investors.
Ineffective forecasts Geopolitics is also a topic that attracts a high level of coverage, which is not necessarily a good thing. “Investors have a near- constant supply of forecasts – most of which will turn out to be wrong,” Mikulskis adds.
TOP FIVE GEOPOLITICAL RISKS
1: US-China strategic competition Issue at risk: China takes military action against Taiwan or asserts claims in the South China Sea by force. Overall view: Military action not expected in the near term, but the risk could increase over time and subject to escalatory triggers.
2: Russia-NATO conflict Issue at risk: Russia launches a large-scale invasion of Ukraine. The US and EU respond with financial, energy and technology sanctions on Russia. Overall view: Russia’s invasion of Ukraine is the largest, most dangerous military conflict in Europe since World War Two.
3: Global technology decoupling Issue at risk: Technology decoupling between the US and China significantly accelerates in scale and scope. Overall view: Strategic competition between the US and China is driving global fragmentation as both aim to boost self-reliance, reduce vulnerabilities and decouple their tech sectors.
4: Major cyberattacks Issue at risk: Cyberattacks cause sustained disruption to critical physical and digital infrastructure. Overall view: The pace of cyber-attacks increases as the Russia-Ukraine conflict persists. Tensions in the Gulf could also lead to increased attacks by Iran.
5: Gulf tensions Issue at risk: Iran nuclear talks collapse, and tensions escalate, raising the risk of a regional conflict. Overall view: The risk of military action in the region is at its highest point in a decade. Source: The Blackrock Geopolitical Risk Indicator
It is almost like the moons are aligning for a more
domestic focus. Richard Tomlinson, Local Pensions Partnership Investments
Nevertheless, asset owners should, he notes, expect their active managers to be assessing the risks posed to their investments and whether these are being rewarded. So how long will the spectre of a geopolitical risk supercycle hang over the global economy and the investment world? Like Lawrence Oates’ walk: it could be some time. “If you take the long view, these type of cycles are generational,” Tomlinson says. This in itself has clear implications for how institutional investors deal with a geopolitical risk supercycle. Investors therefore need to buckle down for a risk supercycle that will shape investment for decades to come. Summing this up for investors is a quote from Sergeant Phil Esterhaus from the 80s TV show, Hill Street Blues: “Let’s be careful out there.”
Issue 124 June 2023 | portfolio institutional | 25
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