The markets often feel unpredictable, in the short term, for the simple reason that they are. However, if we look through the noise and past the media’s headlines, there are plenty of opportunities for investors given the current climate. It is longer-term trends and avoiding market bubbles, such as the sovereign bond from 2020 to 2022, that help grind out positive returns in the long-term.
It’s part of our duty to help you reassure clients and make informed decisions in the face of uncertainty, and from experience, geopolitical risks are often the first concern for a client because they are so widely covered in the mainstream media. We would argue that the headlines are primarily designed to gain an audience’s attention rather than necessarily inform them appropriately.
Unfortunately, one of the foremost influences on market performance comes from the actions and sometimes even just the words emanating from central banks. We say unfortunately because, as the head of one of the most prominent Wall Street investment banks opined last week, the inflation forecasts from eighteen months ago were just “dead wrong.” It’s safe to say, we don’t think anybody should be basing their investment decisions on central bank opinion or projections.
Geopolitical Risks
History shows that reacting to geopolitical events is rarely the best option. Examples such as wars, terrorist attacks and even the covid pandemic demonstrate that market reactions are often short-lived. Counterintuitively, and as difficult as it may be to accept when there are awful human tragedies inevitably involved, events such as these often provide more opportunities than threats for an investor.
Defining Geopolitical Risk
We look at political risks as they portend market risks. It also proved essential to look through political risk and assess the investment opportunities and threats if the risk ultimately subsides.
It’s Importance When Building a Portfolio
It is important to ensure that any knowable geopolitical event has only a limited impact on a portfolio if it comes to pass. Putin’s invasion of Russia is a good example of this, an event that many didn’t expect to happen. The case for Russian assets looked quite strong pre-invasion but then collapsed utterly. Knowing the amounts you have invested in a country suddenly becomes very important when things go wrong.
In the immediate aftermath of that attack, commodity prices were also impacted. The spike, especially in energy sources such as natural gas, hit levels not seen in over a decade. As market participants got their heads around the longer-term ramifications of this invasion, prices dropped back to previous longer-term trends.
The reasons energy prices spiked so severely are worth paying attention to in investing terms. Many parts of the world, and arguably Germany more than most, have found that their previous two-decade-long energy policy had left them incredibly vulnerable and reliant on a friendly Russia. However, we have long commented that the whole commodity and energy complex of much of the developed world has become a victim of short-sightedness, naivety, and attempts by politicians to tell the voters what they want to hear to stay in power.
Several years ago, we brought in specific commodity funds and ensured we had equity managers who understood the investing opportunities brought about by decades-long underinvestment. So, while the Ukraine conflict, and now the outbreak of conflict in the Middle East, have exacerbated the energy shortages and price spikes, the seeds were sown many years previously.
Current Markets or Sectors that Should be Avoided Due to Geopolitical Concerns
The word ‘uninvestable’ is often banded around. Still, too often, the entity saying so is saying what they want to be the case rather than objectively assessing whether something truly is uninvestable. This goes for countries, sectors, and individual companies.
Recent coverage of China is a case in point. Many politicians, mainly from the US, said China was uninvestable, but much of the rhetoric was to score points with their electorate. China is the second biggest global economy, and while it has several complex economic issues to deal with, not least its dysfunctional property market, it is undoubtedly not uninvestable on economic grounds.
The Biggest Geopolitical Risks at the Moment
The most recent tragedy, as mentioned previously, involves several nations and groups in the Middle East currently engaging in acts of warfare. At this early stage, it is hard to quantify the market impact and it depends on how long the conflict will last and which other nations will get involved.
In our opinion, and from a market perspective, China remains a concern but is not uninvestable. Many politicians and commentators have extrapolated from Russia’s invasion of Ukraine that China will necessarily invade Taiwan. In our view, the events of Russia’s invasion make a Chinese invasion less likely. Not even the most ardent Putin supporter could say that the invasion has so far been a success and even less blueprint for any other country to invade its neighbours. Throughout much of this year, we have pointed out that if China does make further missteps with either policy of implementation, it is likely to be other countries within the Asia and emerging markets sphere which could benefit most, not the developed world. For example, when Apple pulled some of its manufacturing from China, it went to India, not North America or Europe.
One of the most significant factors that could affect multiple geopolitical outcomes would be a Trump re-election, but while this might be of concern, there is little that can be done to prepare for such an outcome. Individual countries appear to be prepared in some small ways. Still, suppose Trump is re-elected despite being impeached twice and facing multiple criminal charges. In that case, it’s impossible to say how belligerently he will act and what the outcome will be. A potential Trump re-election is a good example of an event which would cause upheaval but which little can be assumed in terms of outcome. We are aware of the potential geopolitical turmoil his election would cause, but once again, it’s a case of ‘keep calm and carry on’.
Current Market Opportunities
Opportunities for Lower-Risk Clients
Cash accounts currently provide much higher yields than they have for many years. For lower-risk clients still suffering from the effects of last year’s historic bond movements, the temptation may be to hide out in cash. We addressed this issue in last month’s blog: https://www.ibossam.com/the-dilemma-clients-cash-and-timing-the-market/
We have always believed that cash is an asset class in its own right and should always play a part in holistic financial planning and, for most investors, be part of their multi-asset portfolio investment. However, it is worth noting the following points:
- Inflation is much higher than a savings account rate, meaning the client is losing purchasing power in real terms.
- The only return for a cash account is the yield. There is no potential for capital growth (or loss).
- The rates on cash accounts move to reflect the current interest rate and, therefore, may not be a viable long-term investment.
Fixed income assets have disappointed many lower-risk investors following an abysmal 2022. However, for investors who protected capital last year (as our lower-risk portfolios did), the opportunities for fixed income are far more attractive than they have been for several years:
- It is worth remembering that the yield for newly issued bonds needs to be higher than the return on cash. Otherwise, investors would buy cash rather than fund government/corporate debt.
- As such, bond yields are usually much higher than Cash.
- High Yield >10%
- Investment Grade Debt >6%
- UK Gilts >4.7%
- Fixed Income assets can provide capital growth and yield. For example, if the yield of a 5-year gilt fell to 2%, investors would make a 14% return on their capital.
- The potential for bond capital growth was far more limited when yields were at historic lows. This is no longer the case.
- With both a higher yield and the potential for capital growth, fixed-income assets now have the potential to provide diversification against a portfolio’s equity position.
Opportunities for Higher-Risk Clients
In recent years, UK equities faced challenges due to political factors and limited appeal to global investors. Nevertheless, optimism is growing for the UK due to:
- Financials in the FTSE 100 benefit from rising interest rates.
- Oil and mining firms in the index are recovering from underinvestment.
- Low valuations in UK equities offer attractive investment opportunities.
Chinese equities fell 37% in 3 years due to government regulation and ongoing COVID-19 issues. Reasons for optimism include:
- Need for China to maintain economic growth, potentially benefiting risk assets.
- Post-lockdown, the index rose over 15%.
- Attractive valuations, with many tech firms trading at discounts.
Emerging markets, heavily influenced by China’s performance (30% of the EM index), offer diverse investment opportunities. Notable regions include:
- India, the world’s second-most populous nation, has consistently outperformed global equities over five years.
- With significant exposure to financials and materials, Latin America has unique market dynamics and is the best-performing region year-to-date, with a circa 8% gain.
- Taiwan, where TSMC (Taiwan Semiconductor) dominates the index at 43%, plays a crucial role in global chip production and emerging technology products.
Japan is uniquely positioned because inflation is much lower than in many other developed markets, which could present opportunities for investors:
- Japan excels in automation and benefits from optimism about AI.
- A growing emphasis on shareholder value and improved corporate governance is evident, prioritising core businesses over unprofitable side ventures.
Smaller companies offer long-term solid returns, although recent conditions favoured larger ones, we still have a positive outlook that includes:
- Smaller firms have more significant growth potential and can become bigger.
- Global smaller companies outperformed the global index by 472% since 1998.
- Many disruptive technologies and companies originate from smaller firms.
Summary
In summary, we do not look to react to individual events but look to capitalise on longer-term investing trends.
Hopefully, this month’s blog has equipped you with more knowledge and insights to help reassure clients’ concerns and make informed decisions. Geopolitical risks may cast their shadows, but you can ensure a smoother investment journey by exposing clients’ portfolios appropriately to the market’s best opportunities and via thorough diversification.
This communication is designed for professional financial advisers only and is not approved for direct marketing with individual clients. These investments are not suitable for everyone, and you should obtain expert advice from a professional financial adviser. Investments are intended to be held over a medium to long term timescale, taking into account the minimum period of time designated by the risk rating of the particular fund or portfolio, although this does not provide any guarantee that your objectives will be met. Please note that the content is based on the author’s opinion and is not intended as investment advice. It remains the responsibility of the financial adviser to verify the accuracy of the information and assess whether the OEIC fund or discretionary fund management model portfolio is suitable and appropriate for their customer.
Past performance is not a reliable indicator of future performance. The value of investments and the income derived from them can fall as well as rise, and investors may get back less than they invested.
IBOSS Asset Management Limited is authorised and regulated by the Financial Conduct Authority. Financial Services Register Number 697866.
IBOSS Asset Management Limited is owned by Kingswood Holdings Limited, an AIM Listed company incorporated in Guernsey (registered number: 42316).
Registered Office: 2 Sceptre House, Hornbeam Square North, Harrogate, HG2 8PB. Registered in England No: 6427223.
IAM 300.10.23
