Geopolitics and Investment: Understanding the Impact
Introduction
Geopolitics has historically played a significant role in shaping financial volatility and economies. Despite the belief that globalization and the interconnectedness of regional economies would diminish the impact of geopolitics on investments, recent events like the trade dispute between China and the United States have reminded us of its continued relevance. As investors, understanding and effectively managing geopolitical risks are crucial for generating stable long-term returns.
The Changing Landscape
During the Cold War era, tensions between nations often translated into proxy wars and high-stakes diplomacy. However, as the Berlin Wall fell in 1989, many embraced the idea that globalization would render geopolitics nearly irrelevant in investment decisions. The collapse of the Soviet Union and the belief in democratic politics worldwide further reinforced this notion. Yet, the last few decades have shown that geopolitical factors remain pivotal in shaping the economic landscape.
1. Misconceptions Amidst Globalization
Several misconceptions contributed to the neglect of geopolitics in investment frameworks:
- The euphoria following the Soviet Union’s collapse led many to believe in the prevalence of democratic politics globally.
- Assuming that Western powers held the most military power, despite conflicts like the Iraq War.
- Mistaking the interconnected global economy as a new phenomenon, overlooking the long history of international trade.
- Believing that globalization would eliminate conflicts between nations and, consequently, have minimal geopolitical impact.
These misconceptions shaped the investment landscape, diverting attention from the potential risks associated with geopolitical factors.
2. The Rise of China and New Opportunities
The emergence of China as an economic superpower in the late 20th century presented numerous investment opportunities. The “ping pong diplomacy” of the 1970s initiated China’s transformation and its growing rivalry with the United States. However, it also highlighted the need for investors to navigate geopolitical risks and the complex dynamics between major global powers.
Assessing Geopolitical Risks in Investments
While geopolitical risks can introduce volatility and uncertainty, they also present opportunities for savvy investors. However, managing these risks requires a specific set of skills and considerations:
1. Realizing the Dual Nature of Economics and Politics
China’s recent decision to restrict exports of metals used in chip manufacturing amid its trade dispute with the United States illustrates the intersection of economics and politics. Investors must acknowledge that economic decisions are often extensions of political strategies and actions. This understanding can guide investment decisions in a changing geopolitical landscape.
2. Geopolitical Instincts for Investment Managers
Investment managers must develop an instinct for geopolitical risk even if they haven’t personally experienced its full impact yet. This involves staying informed about global geopolitical developments, studying historical precedents, and continuously assessing how these factors may shape the investment landscape. Graduates in politics and history, with their expertise in geopolitical analysis, can provide valuable perspectives and insights within asset management companies.
3. Embracing Diversity of Thought
Incorporating diverse perspectives and backgrounds is essential when assessing geopolitical risks. Candidates with academic backgrounds in politics, history, finance, and economics can collectively offer a holistic approach to understanding and managing geopolitical complexities. Encouraging diversity of thought promotes robust risk assessment and decision-making processes.
4. Incorporating Geopolitical Risk Assessment in Investment Strategies
Asset management companies benefit from adopting comprehensive risk assessment frameworks that encompass geopolitical factors. Similar to evaluating monetary policy, economic risks, and natural risks, considering the impact of geopolitical dynamics ensures a well-rounded investment strategy. Engaging with companies and assessing their positioning for sustainable shareholder returns should include evaluating their understanding and management of geopolitical risks.
Going Beyond the Surface: Unique Insights and Perspectives
While the article highlights the significance of geopolitics in investment decision-making, diving deeper into related concepts and sharing practical examples can provide readers with a richer understanding of the topic.
1. The Power of Historical Patterns
Studying historical patterns can shed light on the potential impact of geopolitical risks on investments. For instance, examining how previous conflicts, such as the Yom Kippur War in 1973, influenced financial markets and economies can guide investor strategies. Historical analysis can help develop a framework for anticipating potential geopolitical risks and their corresponding implications for investments.
2. The Influence of Technological Advancements
In an interconnected world driven by technological advancements, geopolitical risks take on new dimensions. Cybersecurity threats, intellectual property disputes, and the rise of artificial intelligence are just a few examples of how technology intertwines with geopolitics. Recognizing these complex interdependencies allows investors to stay ahead of emerging risks and identify opportunities within evolving geopolitical landscapes.
3. Environmental Factors and Geopolitics
Climate change and environmental concerns have increasingly become intertwined with geopolitical dynamics. Rising sea levels, resource scarcity, and the displacement of populations due to ecological factors can trigger conflicts and influence investment decisions. Investors who incorporate these factors into their analysis can proactively navigate the challenges and capitalize on the opportunities presented by the evolving environmental landscape.
4. The Role of Multilateral Organizations
Multilateral organizations and agreements play a crucial role in shaping geopolitics and investment landscapes. Understanding the influence of organizations like the United Nations, World Trade Organization, and regional institutions can provide insights into geopolitical risks and how they impact investments across borders. Monitoring geopolitical developments within the context of multilateral relationships allows investors to anticipate shifts in global dynamics and adjust their strategies accordingly.
Summary
Geopolitics undeniably affects financial markets and economies, necessitating a comprehensive understanding and management of associated risks for investors. Despite previous beliefs that globalization would render geopolitics less influential, recent events have demonstrated the continued significance of geopolitical factors in shaping investment outcomes.
Investment managers who possess the skills and knowledge to navigate geopolitical risks are better positioned to generate stable long-term returns. Recognizing the dual nature of economics and politics, developing geopolitical instincts, embracing diversity of thought, and incorporating geopolitical risk assessment into investment strategies are essential steps in effectively managing geopolitical risks.
Furthermore, delving deeper into historical patterns, technological advancements, environmental factors, and the role of multilateral organizations provides additional perspectives and insights for investors. By considering these aspects, investors can gain a more comprehensive understanding of the interconnectedness between geopolitics and investments.
As geopolitical landscapes evolve, it is crucial for investors to stay informed, adapt to changing dynamics, and continuously evaluate the impact of geopolitical risks on investment decisions. By doing so, investors can position themselves for success in an ever-changing global economy.
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The author is Managing Director of Federated Hermes Limited
There was a time when investors understood that geopolitics had a real impact on financial volatility and economies. During the Cold War, international tensions manifested themselves in a mixture of proxy wars and high-stakes diplomacy. As a young boy in East Jerusalem in the late 1960s, I experienced one such proxy war in June 1967. This experience taught me that risk is not the same as volatility – the first involves the possibility of losing everything.
The peak of this era came in 1973. The same year that heralded the US withdrawal from Vietnam also saw the Yom Kippur War and subsequent oil price crisis. Then, in 1989, the Berlin Wall came down and political scientist Francis Fukuyama declared the “end of history”.
Thus began, nearly 30 years ago, the widely held belief that globalization represented the intertwining of regional economies and the end of geopolitics affecting investment except in marginal developing economies.
By the time Russian tanks entered Ukraine last year, we had experienced a period of global calm, compared to much of the previous century. As a result, many investors had, in my opinion, forgotten how central geopolitics can be in making investment decisions.
There were perhaps three reasons why geopolitics took a back seat in investor frameworks. First, the euphoria that followed the collapse of the Soviet Union wrongly convinced many that we had entered an era of democratic politics around the world. Many also believed that the Western powers wielded the most military power, as the war in Iraq earlier this century showed.
Second, a connected global economy was mistakenly believed to be a new phenomenon, when in fact international trade dates back to antiquity.
Third, the idea germinated that this interconnection would lead to the end of conflicts between nations and that geopolitical difficulties would no longer have an impact on the economic landscape.
Arguably, the seeds of the new era were laid with the “ping pong diplomacy” of the 1970s and the beginning of China’s transformation into the economic superpower it is today. This generated many opportunities for investors (who ignored the inevitable growing rivalry between Beijing and Washington).
Today, China’s recent decision to restrict exports of two key metals used in chip manufacturing, due to its trade dispute with the United States, reminds us that economics is an extension of politics by other ways. This does not mean that there are no opportunities to invest and even profit from the emergence of a new economic landscape. But investors need a specific set of skills to do so.
Managers who can manage today’s geopolitical risks are best placed to generate stable long-term returns. Those who disregard these risks may not just experience temporary volatility, but could actually lose all of their clients’ money – as investors in Russian assets have learned the hard way, following President Vladimir Putin’s decision to invade Ukraine.
The challenge for fund managers today is to have an instinct for geopolitical risk when, in most cases, they haven’t actually experienced it.
Asset management companies need to ensure they have the skills needed for today’s world. The industry should consider where it recruits from, for example, to equip itself with the right prospects and expertise. Graduates in politics and history are as important and relevant today as those who studied finance and economics. Diversity of thought is as important as diversity of origin. Often the two go together.
Two decades ago, we invested in creating an engagement arm. This unit speaks to companies and asks them about the types and range of risks they consider, to help them assess how sustainably positioned they are to generate shareholder returns. Geopolitical risk is part of this assessment. This is no less relevant in developed markets than in developing ones, as the UK Trussonomics episode and recent anti-police protests in France have demonstrated.
Of course, we must continue to consider the impact of monetary policy, as well as economic and natural risks, in combination with the effects of geopolitics. Many of these factors are interconnected, such as the possibility of mass migrations caused by the ideological whims of individual states or climate change.
As an investor, considering these geopolitical risks could be the crucial difference between securing your returns or ending up with nothing.
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