There was a time when investors understood that geopolitics and, particularly, the Cold War between the Soviet Union and the West, had a real impact on financial volatility and economies as it played out in a mixture of proxy wars and unusual diplomacy. As a young boy in East Jerusalem in the late sixties, I lived through one such proxy war in June 1967. That experience taught me that risk is not the same as volatility, but rather the possibility of losing everything.
Perhaps the peak of that epoch came in 1973. The same year that heralded the US withdrawal from Vietnam with the signing of the Paris Peace Accords also saw the Fourth Arab-Israeli War take place and ensuing oil price crisis. By 1989, with the economic decline of the USSR, the Berlin Wall came down and the political scientist Francis Fukuyama famously declared the ‘end of history’.
That began, almost 30 years ago, a belief that globalisation represented an intertwining of regional economics and a divorce from geopolitics, except in fringe developing economies. Yes, 9/11 introduced the uncertainty of terrorist attacks in the US (we had dealt with it here for many years during the Troubles) and the subsequent wars were an attempt to deal with non-state actors.
But by the time Russian tanks rolled into Ukraine we had lived through a period of comparative calm when it came to adverse geopolitical events – especially compared to much of the 20th Century. As a result many investors, I would argue, had forgotten how central geopolitics can be to making investment decisions.
The return of geopolitics as an investment factor
There were, perhaps, three specific reasons why geopolitics took a back seat. First, the general euphoria that followed the collapse of the Soviet Union incorrectly convinced many that we had entered an era of hegemony for democracies (hence Fukuyama’s article) as a political philosophy and military dominance of Western powers, which is what to many the second Iraq war seemed to demonstrate.
Second, there was a false belief that a connected global economy was a new phenomenon. Finally, the idea grew that this interconnectedness would lead to the end of conflict and geopolitics as part of the economic factor landscape.
Arguably, the seeds of the new era were laid with the so-called ‘Ping-Pong Diplomacy’ of the 1970s and the transformation of China over time into the economic superpower it is today. This generated extensive opportunities for investors (who overlooked the inevitable rising rivalry between China and the US). However, Russia’s attempt to annex Ukraine reminded many that China views Taiwan as part of the Middle Kingdom and the South Sea as a Chinese zone of influence.
China’s recent move to restrict exports of two key metals used for chipmaking, due to its trade dispute with the US, reminds us that economics is an extension of politics by other means. That is not to say there are no opportunities to invest and indeed benefit from the emergence of a new economic landscape. But it does need a specific set of skills in the investment arsenal to do so.
Managers who can navigate today’s geopolitical risks are, in my view, the ones best placed to generate long-term, stable returns. Those who fail to take account of such risks may not simply experience volatility, but may discover that risk means losing all their clients’ money—as those invested in Russian assets found out following Vladimir Putin’s decision to invade Ukraine.
State-based conflicts, world, 1946 to 2020
Open a different book or newspaper
The challenge, therefore, for fund managers today is having the instinct for geopolitical risk when so few have experienced it.
In that sense, asset management houses need to make sure they have the relevant skills for today’s world. The industry should consider where they may want to recruit from, for example, to equip themselves with right skills and expertise. Graduates with politics and history degrees are as important and relevant today as those with finance and economics ones. Diversity of thought is as important as diversity of background. Often, the two go together.
That is why at Federated Hermes, we invested in the creation of an engagement arm two decades ago. We use this part of our business to talk to firms and challenge them on what risks they consider, to help assess how sustainably companies are positioned to deliver returns to shareholders. Geopolitical risk is part of that assessment. This is no less relevant in developed markets than in developing ones, as the Prime Minister Liz Truss episode and recent French riots demonstrated.
Of course, we should continue to consider the impact of monetary policy, fiscal, economic and nature risks, in combination with the effects of geopolitics. Many of these factors are a source of deep concern on a human level, and they are interconnected, including the potential for further mass migrations caused by the ideological whims of individual states or climate change.
As an investor, taking heed of these risks could be the crucial difference between securing your returns or ending up with nothing.
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