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The writer is chief executive 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 played out via a blend of proxy wars and high-stakes diplomacy. As a young boy in East Jerusalem in the late sixties, I lived through one such proxy war in June 1967. That experience taught me that risk is not the same as volatility — the former carries the possibility of losing everything.
The peak of that era came in 1973. The same year that heralded the US withdrawal from Vietnam also saw the Yom Kippur war, and the ensuing oil price crisis. Then in 1989 the Berlin Wall came down, and the political scientist Francis Fukuyama declared the “end of history”.
Thus began, almost 30 years ago, the widespread belief that globalisation represented the intertwining of regional economics and an end to geopolitics affecting investments, except in fringe developing economies.
By the time Russian tanks rolled into Ukraine last year, we had lived through a period of global calm, relative to much of the previous century. As a result, many investors had, in my view, forgotten how central geopolitics can be to 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 incorrectly convinced many that we had entered an era of democratic politics the world over. Many also thought that western powers held the most military might, as signified by the Iraq war at the beginning of this century.
Second, there was a false belief that a connected global economy was a new phenomenon, when, in fact, international trade dates back to ancient times.
Third, the idea grew that this interconnectedness would lead to the end of conflict between nations, and geopolitical difficulties would no longer impact on the economic landscape.
Arguably, the seeds of the new era were laid with the “ping-pong diplomacy” of the 1970s, and the start of the transformation of China into the economic superpower it is today. This generated extensive opportunities for investors (who overlooked the inevitable rising rivalry between Beijing and Washington).
Today, China’s recent move to restrict exports of two key metals used for chipmaking, due to its trade dispute with the US, reminds us that economics is an extension of politics by other means. That is not to say there are no opportunities to invest and indeed benefit from the emergence of a new economic landscape. But investors need a specific set of skills in order to do so.
Managers who can navigate today’s geopolitical risks are the ones who are best placed to generate long-term, stable returns. Those who fail to take account of such risks may not simply experience temporary volatility, but could actually lose all of their clients’ money — as those invested in Russian assets learnt the hard way, following President Vladimir Putin’s decision to invade Ukraine.
The challenge for fund managers today is having an instinct for geopolitical risk when, in most cases, they haven’t actually experienced it.
Asset management houses need to make sure they have the relevant skills for today’s world. The industry should consider where they recruit from, for example, to equip themselves with right perspectives and expertise. Graduates with politics and history degrees are as important and relevant today as those who have studied finance and economics. Diversity of thought is as important as diversity of background. Often, the two go together.
Two decades ago, we invested in the creation of an engagement arm. This unit talks to companies and challenge them on the types and range of risks that they consider, to help assess how sustainably they are positioned to deliver returns to shareholders. Geopolitical risk is part of that assessment. This is no less relevant in developed markets than in developing ones, as the Britain’s Trussonomics episode and the recent anti-police protests in France have demonstrated.
Of course, we should 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, taking heed of these geopolitical risks could be the crucial difference between securing your returns or ending up with nothing.
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