The $223 billion Future Fund intends to keep its eyes wide open amid global geopolitical tensions and refrain from over or underestimating their impact on financial markets. The traditional definition of geopolitics is event-focused, but the fund outlined in its latest position paper that it’s really the event implications that matter most to investors.
The publication, Geopolitics: the Bedrock of the New Investment Order, comes as investors around the world grapple with a regime shift that sees assumed knowledge of investing, like stock-bond negative correlation, thrown out of the window.
When dealing with geopolitics specifically, the fund said it can be quite difficult to meaningfully model or measure geopolitical scenarios and investors should “instead focus much more on both the monitoring and managing phases”, the paper said,
Knowing what to monitor is also important. The Future Fund said the main trends it is monitoring are changing trade dynamics, a rise in strategic competition, and growing populism. But the trend investors most likely to “overemphasise, or mis-read” is the increasing risk of conflict.
“Few conflicts have long-term impacts on global financial markets; those that have, have needed to escalate into either major global events or to have been associated with large commodity shocks for their impact to be enduring,” the paper said.
“This said, we do note that the risk of conflict is increasing and is therefore something we must consider in our asset allocation and portfolio design. We do not look to trade these episodes though, given their capricious nature.
“Rather, we seek to manage the risk from such events and own exposures that can survive any potential intense reactions and, ideally, thrive through the recovery.”
No more ‘free lunch’
This resonated with recent comments made by Australian Retirement Trust and HESTA that geopolitics is a difficult place for super funds to gain an edge. HESTA chief investment officer Sonya Sawtell-Rickson said while the fund conducts scenario analysis about geopolitical risks, it’s hard to run an investment process based on that in a “consistent and repeatable” way that delivers performance through time.
The Future Fund’s way of responding to geopolitical risks is by incorporating “true diversifiers”, echoing its previous position paper titled The death of traditional portfolio construction?.
“Instead of relying solely on government bonds for that much-needed diversification – as per traditional portfolio construction – we are turning to more true diversifiers in our portfolio: exposures that come from non-directional alternative/hedge fund strategies such as equity market-neutral or systematic macro strategies, for example,” the latest paper said.
The fund also warned that some “free lunch” in diversification that investors have become used to is no longer effective, such as geographic diversification, as the world shapes around alliances and transforms into a trading blocs-like landscape.
“Certain jurisdictions may not be as open to free capital flows in the future, with the spectre of capital controls or sanctions under certain extreme scenarios,” the paper said.
“As well, the rising share of some countries in emerging market equity and bond indices may lead some investors to reconsider the use of standard market-cap indices.”
“If geopolitics is to teach us all anything, it is to stay humble. Investors of all types would be wise to become well-versed on the dimensions and likely implications of the challenges that arise from geopolitics. The era of being able to ignore this inimitable force is over.”
