Geopolitical risk: Investing for the new geopolitical reality

by

15 Oct 2013

The risk landscape for investors has changed. Europe appears to be on the mend and markets are less sensitive to political developments as confidence returns in the value of the euro. The world has now shifted to a Fed-led paradigm dominated by uncertainty about when the taper will start and how soon interest rates will rise. Meanwhile, the Arab Spring continues to throw up significant global risk and inflate the oil price, creating a drag on global growth. In this new environment, volatility will prevail and likely increase across currencies, bonds and equities, which could hurt those ill prepared for its consequences.

Features

Web Share

The risk landscape for investors has changed. Europe appears to be on the mend and markets are less sensitive to political developments as confidence returns in the value of the euro. The world has now shifted to a Fed-led paradigm dominated by uncertainty about when the taper will start and how soon interest rates will rise. Meanwhile, the Arab Spring continues to throw up significant global risk and inflate the oil price, creating a drag on global growth. In this new environment, volatility will prevail and likely increase across currencies, bonds and equities, which could hurt those ill prepared for its consequences.

The risk landscape for investors has changed. Europe appears to be on the mend and markets are less sensitive to political developments as confidence returns in the value of the euro. The world has now shifted to a Fed-led paradigm dominated by uncertainty about when the taper will start and how soon interest rates will rise. Meanwhile, the Arab Spring continues to throw up significant global risk and inflate the oil price, creating a drag on global growth. In this new environment, volatility will prevail and likely increase across currencies, bonds and equities, which could hurt those ill prepared for its consequences.

“In the past geopolitical stability allowed for long-term economic planning, but now we are in a game that includes Iran, Israel, Russia, China, Japan, US and Eu

Tom Clarke

“We have moved into a geopolitically unstable world with multiple players and objectives,” says Tom Clarke, portfolio manager at William Blair. “In the past geopolitical stability allowed for long-term economic planning, but now we are in a multi-player game that includes Iran, Israel, Russia, China, Japan, the US and Europe where information is much less complete.”

The shoots of growth still look fragile – the Fed’s backward step on tapering reveals the extent to which it fears destabilising the path to recovery. High oil prices will only serve as a further headwind to recovery. The result will likely be a continuation of the limbo markets have been in since May when the Fed first mentioned tapering. Although a temporary reprieve has been granted, which will be particularly beneficial to emerging markets, the underlying weaknesses remain.

As Peter O’Flanagan, head of FX dealing at Clear Currency says: “I’d suggest making hay while the sun shines, as long as the US remains loose on monetary policy stocks and emerging markets should benefit, but it is important to manage risks. Some emerging currencies and markets have their own fundamental weaknesses. Booking profits or adding hedges as the market rises is key as the possibility of a quick reverse is real should we see a pick-up in the pace of US growth.”

The eventual reduction in bond buying by the Fed will likely cause significant volatility in equity markets, particularly in emerging countries where the period of ‘taper talk’ has brought realisation of just how far many key emerging markets have yet to go in creating structural change. Even in fixed income assets, as the Fed confuses markets by chopping and changing its plans, the path to normalisation will not be smooth.

As one senior pensions official for a large, London-based fund said: “There is no doubt volatility will increase and some form of management of that, whether through derivatives or risk-offsetting elsewhere in the portfolio, will be essential.”

Comments

More Articles

Subscribe

Subscribe to Our Newsletter and Magazine

Sign up to the portfolio institutional newsletter to receive a weekly update with our latest features, interviews, ESG content, opinion, roundtables and event invites. Institutional investors also qualify for a free-of-charge magazine subscription.

×