A 24-hour media cycle may be overstating the level of geopolitical risk in the world and factors behind the headline news should be considered when constructing portfolios, Legal & General Investment Management (LGIM) has cautioned.
Emiel van den Heiligenberg, head of asset allocation at LGIM, said uncertainty is often confused with risk and investors should look beyond temporary conflicts that make news headlines.
“We think investors have learned from 9/11 not to over exaggerate the long-term global impact,” Emiel van den Heiligenberg, LGIM. “Almost by definition most geopolitical incidents are quite unpredictable, the impact on markets is always immediate (so it is difficult to get ahead of the curve), and, while sometimes the instantaneous impact is really significant, it is rarely lasting,” said van den Heiligenberg. “The usual initial market reaction is an increase in equity risk premium, a rise in volatility, a fall in government bond yields (even though some shocks are actually inflationary), and a fairly mixed reaction in oil and gold, depending on the nature and the location of the conflict.”
Local markets take much more of an impact than those further away, with the US and UK markets the most shielded even from their own domestic events, such as 9/11 or the London bombings, van den Heiligenberg said.
“We think investors have learned from 9/11 not to over exaggerate the long-term global impact, especially when policymakers pledge their support and reduce interest rates, for example,” he added. “This explains why some of the recent geopolitical conflicts, like Syria and Gaza, though disastrous from a human perspective, haven’t had too much lasting impact on markets, so far.”
Investors should instead consider the longer-term shifts around the world that could have a heavier bearing on the positioning of their portfolios.
“I can’t help thinking that we will see a pendulum shift from a period where we enjoyed the benefits of a ‘peace dividend’ of the 1990s thanks to the fall of the Berlin Wall, globalisation, and growing economic prosperity towards a period of elevated geopolitical risks,” van den Heiligenberg said.
These risks included the rising income inequality around the world. This has been evidenced by data from the OECD showing the average income of the richest 10% of people has risen to nine times the income of the poorest 10%, from seven times 25 years ago.
“This results in an increasing risk that an extremist party gets voted into government in a major developed economy,” van den Heiligenberg said.
The role of the US, which had typically acted as a global police force, has shifted to take a more “isolationist” view, he said. This meant the world’s largest economy—and superpower—was more concerned with its own issues than preserving world order.
The digital revolution, which has helped world progress in many ways, has begun to spawn its own troubles, van den Heiligenberg said, citing Russian hackers stealing more than one billion internet passwords in a recent heist reported by the New York Times.
However, adjusting investment portfolios to take risks—either temporary ruptures or more long-term features—is not easy, van den Heiligenberg admitted.
“Even though you can make some generalisations on the market reaction when geopolitical events occur, there is no such thing as a standard market reaction to a geopolitical crisis,” he said. “To manage your portfolio it is crucial to analyse each event on its own specific merits and to make a judgement call on the long-lasting consequences for the economic and earnings fundamentals.”
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