A Primer on Geopolitics and Investing
Aim: To provide advisers with insights into how current and future geopolitical risk might affect investment opportunities and returns.
Outcome: Completion of this module will enable financial advisers (audience) to understand:
- What geopolitical risk is and how geopolitical risks and tensions might impact on clients’ investment returns;
- Use that knowledge when evaluating investment strategies for clients.
Abstract: A broad framework on how to think about geopolitical risk and relate it to investment is provided. The approach to geopolitical analysis assesses risk as the chance of deviation from an expected outcome, either good or bad. It uses three frameworks:
- Overstated and understated risks - media tend to distort geopolitical risk perceptions. Often, risks are overstated or misinterpreted (red herrings). Other, more important risks, are often ignored or understated (leaving the potential to blindside).
- Exogenous and endogenous risks - Many investors believe geopolitics are exogenous from investment markets. But, often, geopolitical risk is endogenous, as it underlies assumptions in how countries will behave.
- Scenario analysis - Geopolitical strategy considers all forecasts as probabilistic. It looks for probabilities of outcomes, catalysts and implications.
The world is currently moving into a multipolar state - an era where there are a number of great powers in the world, as the global dominance of the US alone begins to diminish. Now, there are a number of countries that can pursue independent and globally relevant foreign policy. Multi-polarity can be balanced or unbalanced and the world now approximates an unbalanced multi-polar world. Multi-polarity is often associated with global volatility and is more likely to cause military conflict, depending on the type of multi-polarity.
Three main trends that will develop over coming years as a result of these changes in global power balances are explained, and it is argued that this rebalancing of geopolitical positioning will also mean geopolitics will become much more important for markets than it was.
Inflation may no longer be the focus of monetary policy, as it has been for the past 50 years or so. That mandate may be quietly changing amongst central banks and examples of this are provided suggesting that keeping inflation low is not the policy anchor it once was. If this is the case the implications include:
- An easy global monetary policy, which will be broadly supportive of equities;
- Inflation will remain low due to excess capacity and a global savings glut, meaning interest rates can remain low;
- Due to low interest rates, high levels of government debt levels will be sustainable.