If you catch the news now and again you’ll be well aware that geopolitical events are commonplace around the world. These events have the potential to materially change a country’s fundamental economic outlook, but can also have an impact – either directly or indirectly – on the returns of various assets in a fund’s portfolio.
To take a fairly recent example, Ukraine has been gripped by political unrest since late 2013, which descended into violence in early 2014. Focusing solely on the economic and financial market implications, this event raised investor concerns toward the profitability within parts of Europe’s banking and manufacturing sectors, and toward the heavy reliance countries such as Germany have on Russia’s gas exports. It also placed strains on Russia’s banking sector and economy after Western countries enacted various trade sanctions.
While falling oil prices is another key factor, heightened geopolitical tensions contributed toward Russia’s equity market underperforming the US S&P 500 by about 57% over 2014. Other flow on effects were that it guided German 10-year Bund yields to a (then) record low last year; and raised price volatility in the global markets for crude oil, selected base metals and soft commodities.
Typically geopolitical events are highly unpredictable, often swift, and can shift market volatility and sentiment significantly. This can affect asset values both within and outside the country where the event is happening. So how can an institutional investor respond?
While the unpredictability of geopolitical events on financial asset returns supports the case for a highly diversified portfolio, it raises a key point of difference among various fund managers. Geopolitical events can cause asset prices to move away from what would be considered ‘fair value’ under more normal conditions. Some managers consider this mispricing in their investment decisions. Others choose to avoid such exposures altogether owing to the associated uncertainty and risk of heightened volatility, and some fund managers remain agnostic to the impact of such events.
Much like other Australian superannuation funds, a large slice of QSuper’s investment portfolio is invested offshore. Therefore, while we place high importance on diversification, significant geopolitical events are not ignored. QSuper’s Investment Strategy Team, under delegation from the Board, is able to move the portfolios within specific asset class ranges approved by the QSuper Investment Committee and endorsed by the Board. You can view asset allocation ranges for each investment option in the Investments section of the website.
Specifically, this process enables the portfolio’s exposure to a particular asset class, country, or sector of an equity market to be adjusted if we believe the relative risk and return trade-offs for a particular asset class have changed. It therefore offers a means of protecting the portfolio from geopolitical uncertainty. The team also has the ability to buy specific equity option-protection exposure to limit the negative impacts a specific event may have on share returns, if we believe the probability of a specific event occurring was high enough.
If we decide to take action to adjust the portfolio, we continue to monitor whether or not it remains warranted going forward. So while this is really just an overview of the potential impacts of geopolitical events on our portfolio, it hopefully gives you some insight into how we manage risk beyond the more obvious financial risks.
The views of the author and those who provide the responses to comments posted on this blog are not necessarily the views of QSuper. This information is for general purposes only. It is not intended to constitute advice and persons should seek professional advice before relying on this information.
Past performance is not a reliable indicator of future performance. Each of our investment options has a different objective, risk profile, and asset allocation.
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