Have we seen the end of globalisation? - IMAP Independent Thought

By Jayson Forrest

A war in Ukraine, rising tensions over China, and political events worldwide have caused a sharp jump in risk levels for financial markets. Jonathon Costello (Western Asset), Chris Carrodus (Evidentia), David Berthon-Jones (Aequitas), Matthew Swieconek (Findex), and Brett Sanders (Philo Capital Advisers) discuss these rising risks when constructing portfolios.

Whether it’s conflict in Ukraine, growing tensions with China over Taiwan, the election of extremist governments, the rise in economic protectionism, cyber attacks, or the after-effects of COVID - geopolitical events have touched all economies. And the impact has been obvious: higher commodity prices, supply chain disruption, additional monetary tightening by central banks, increased pressure on wages, and further downside risk to global growth, which have all helped lift inflation, adding considerable pressure to the cost of living.

As evidenced this year with the conflict in Ukraine, there’s no doubt that geopolitics can create significant market volatility and uncertainty, a fact not lost on Jonathon Costello - Client Service Executive at Western Asset.

“When you consider all these geopolitical issues, without a backdrop of growth supporting the global economy, then these types of geopolitical risks are going to be much more of a factor going forward when constructing portfolios,” says Jonathon.

Speaking at the IMAP Independent Thought Conference in Melbourne, Jonathon says when considering geopolitics, Australia remains relatively attractive for investors, due to its stability and the resilience of its resources sector.

“This demonstrates the need to pursue quality businesses that have strong cashflows, are in regulated sectors, and have good management teams,” he says. “This is particularly the case when faced with a very uncertain and volatile geopolitical environment. That’s when it’s essential that portfolio managers and advisers focus on long-term fundamental value and diversified strategies.”

However, Jonathon concedes that when looking at the bond market, as well as other traditional asset classes over the last year, it has been very challenging for advisers, but he believes there are still some attractive yields available within defensive asset classes.

“With bond yields so low, investors have had to reach for growth assets, while diversifying the alternatives bucket within their portfolios into the likes of private equity, venture capital, and infrastructure. But now, fixed income is definitely relevant again. You’re looking at 5 per cent yields within the Australian bond market, which makes fixed income a relevant and opportune investment for a diversified portfolio.”  

Matthew Swieconek - Head of Investment Relations at Findex - echoes Jonathon’s view on Australian resources, with Findex maintaining a bullish view on the materials sector, which is reflected in its overweight position in Australian equities. 

“When it comes to portfolio construction and making sector bets, we always consider our client demographic,” says Matthew. “As a consequence, it makes sense that we’ve got a fully diversified portfolio across investment styles.”

It’s a similar position for asset consultant, Evidentia Group, which currently remains neutral in terms of Australian versus global equities. However, with the company’s Senior Asset Consultant, Chris Carrodus, forecasting that inflation and interest rates will peak lower in Australia than the U.S., he believes this will encourage Evidentia to tilt more to the Australian market relative to international, as part of its portfolio construction considerations. 

Tackling geopolitics within a portfolio construction framework can be challenging. Part of this challenge is being clear about the differences between geopolitical events, which tend to be short-term and isolated in nature, and geopolitical shifts, which are more long-term and impactful.

“The reason why it’s important to distinguish between these differences is because, as an asset allocator, we are more interested in medium and long-term impacts on markets, and less so on the short-term,” says Chris.

He adds that because the vast majority of geopolitical events are short-term, the long-term impact on markets is relatively limited. However, Chris concedes that long-term geopolitical shifts can be difficult to predict.

“So, as a boutique asset consultant, when it comes to geopolitics, we need to be realistic about where we think we can add value. That affects how these geopolitical events or shifts are factored into an SAA decision, a TAA decision, or a securities selection decision,” he says.

Evidentia believes a geopolitical shift is happening now, which had its beginnings in the pre-COVID trade tensions between the U.S. and China. And while those tensions are ongoing, this shift has also escalated to friction between China and Taiwan, conflict between Russia and Ukraine, and rising tensions between NATO and Russia. This has all flowed through to increased energy prices, and rising interest rates and inflation, which has put considerable downward pressure on global economic growth.

“Although these are much longer tail themes, we believe they will impact our longer term SAA forecasts in how we build portfolios, which will then be a factor in how we make our DAA decisions, and even how we allocate capital through managers,” says Chris.

“For example, in emerging markets, we are much more benchmark unaware, because if you believe in deglobalisation and shifting supply chains, as we do, then there are going to be significant winners and losers from that, and particularly in emerging markets. So, you want to have the ability to be more active around country and sector selection, and be much less benchmark aware in that particular environment.”

As globalisation gained momentum over the last few decades, with countries putting aside their ideologies and vested interests to be part of a shared economic vision, that global vision has begun to fracture. The world is increasingly dividing on values and ideological lines - with democratic countries standing together against autocratic regimes - which is fundamentally driving many of the geopolitical issues happening today.

Brett Sanders - Chief Executive Officer at Philo Capital Advisers - shares Evidentia’s belief that this shift to deglobalisation is occurring, as countries steadily manoeuvre into ideological blocks. It’s also a view supported by asset consultant and portfolio manager, Aequitas Investment Partners. According to its Joint Chief Investment Officer, David Berthon-Jones, the best approach to dealing with this global realignment is to “spread the capital far and wide” across geographies, sectors, and styles.

“And investors need to make sure there are no hero trades in their portfolio for what is essentially an unknowable political and regional dynamic,” he advises.

As part of this ideological realignment, Chris also believes that longer-term thematic shifts, like the tensions between the U.S. and China, will continue to be slow moving, with any significant event around that thematic being less likely. However, he anticipates that other sub-themes currently playing out, like further crackdowns in technology sharing between the U.S. and China, are becoming a little more predictable for portfolio managers, enabling them to more accurately reflect these sub-themes in their SAA and DAA decision-making process.

Unfortunately, one of the consequences of geopolitics is the attention and anxiety it creates for investors. So, how should advisers engage with clients about geopolitics?

For David, it’s about addressing the cause of their fears and re-emphasising that throughout history, human ingenuity has been very successful in overcoming challenges. He believes by using examples of how markets have reacted and rebounded to previous geopolitical events, such as the GFC and COVID, can be reassuring for clients.

It’s a similar position that Findex takes when addressing client concerns that are fielded by its 110 advisers across the country.

“Clients are learning about these issues through the media, which they find concerning,” Matthew says. “However, we’re fortunate in that we have many clients who have been with us through previous downturns and for these clients, they know how to weather market volatility.”

He says Findex’s approach is to try and keep its client engagement about geopolitics as simple as possible. It does this by acknowledging that recent events, like the Ukraine/Russia conflict or the COVID pandemic, are very hard to predict.

“We explain that although the catalysts triggering these events is different each time around, and while the market may react to them by capitulating for a time, it inevitably rallies and reverts to the mean over a period of time,” says Matthew.

“And yes, this time around it is different, where fixed income and equities have fallen together, which is highly unusual. But we explain to clients that if they are invested for the long-term, then these geopolitical events are bumps along their investment journey, which the market has been through many times before.

“And although the catalysts for these events might be different, the outcomes are typically the same in terms of an investment’s long-term returns and the performance of the market, provided investors are holding good quality assets and are working with managers that can ride out market volatility.”   

Jonathon Costello is a Client Service Executive at Western Asset;

Chris Carrodus is a Senior Asset Consultant at Evidentia Group;

David Berthon-Jones is Joint Chief Investment Officer at Aequitas Investment Partners; and

Matthew Swieconek is Head of Investment Relations at Findex.

They spoke on ‘Geopolitics and the implications for portfolio construction’ at the IMAP Independent Thought Conference - Melbourne.

The session was moderated by Brett Sanders - Chief Executive Officer at Philo Capital Advisers.