Geopolitical risk in investing: industry experts reveal regional outlooks in ii masterclass

A recent interactive investor event looked at why investors should not underestimate political risks.

Recently, interactive investor, the UK’s second-largest private investor platform, hosted an event for its customers which explored why investors should not underestimate political risks.

The event, which ii customers could register to watch live, featured several experienced investment experts and outlined the geopolitical landscape for investors, and how retail investors should be thinking about these issues when looking at their own portfolios.

These events are designed to guide investors through themes and topics that might impact how they are looking at their investment and give them more of the tools and knowledge to become better investors.

We are living in a highly unpredictable and volatile world. As the panellists discussed, headwinds investors need to navigate include the devastating invasion of Ukraine, higher interest rates, and continued tension between the US and China – particularly in terms of trade. One of the key focuses of the panel’s concerns was recession risk.

The event was chaired by Moira O’Neill, Head of Personal Finance at interactive investor.

Joining ii’s distinguished panel was a range of investment experts. Namely: Michael Grady, Head of Investment Strategy at Aviva Investors, Trevor Greetham, Head of Multi-Asset at Royal London Asset Management, and Gareth Witcomb, manager of JPMorgan Multi-Asset Growth & Income.

Giving the broader market backdrop, the panel was joined by ii’s very own Head of Investment, Victoria Scholar.

The recent sea change in markets: despite volatility, are there still opportunities for investors?

Setting the scene, Victoria Scholar, explained:“Markets were seemingly unstoppable for a number of years, underpinned by cheap money and rock-bottom interest rates. However, post-pandemic we have seen a real sea-change in the markets; we’ve seen the spectre of inflation, a spectre that needs to be tempered. We’ve therefore moved from monetary accommodation to monetary tightening, in turn – spooking markets. As we’ve seen, technology stocks, in particular, have really bore the brunt of selling so far this year.”

Scholar added: “That said, there have been pockets of outperformance in certain sectors -commodities being one of them, and we have also seen the FTSE 100, for example, hold up fairly resiliently. This is thanks to its favourable sectoral mix – leaning towards the banks and some of those big oil stocks like BP and Shell. So, despite the volatility, there are still potential opportunities.”

The impact of the war in Ukraine

Scholar stated:“The devastating war in Ukraine has created a lot of supply uncertainty – we’ve seen oil prices move to triple digits; we are also seeing soft commodities sharply higher… I don’t think the markets perhaps realised just how dependent we were on Russia and Ukraine for certain commodities, and that’s really been showcased by some of these dramatic price rises.”

A bumpy ride to recession, with lots of blame flying round

Trevor Greetham, Head of Multi-Asset, Royal London Asset Management, believes recessionary risk is something investors should be acutely aware of.

He told the panel: “The most obvious risk is recession risk. This follows on from the inflationary environment we currently find ourselves in. Inflation is very high, and it’s persistently high. The invasion of Ukraine was unexpected and pushed commodity prices up – they’re up 40% this year – and the hard lockdowns in Beijing and Shanghai have also negatively impacted supply chains. Central banks couldn’t have forecast these events, but that’s where we are.

“To get inflation back out of the system, they need to raise interest rates until the economies create the spare capacity that is needed. That means creating recessions.

“One thing we should be very aware of in this country is that we have not had a recession that you can really pin on a central bank in the UK since the Bank of England got its independence in 1997, and politicians are already pointing the finger because they don’t want to take the blame. Questions will be raised about the need for such strict inflation targets.

“Inflation is hitting us all the time, and as an investor you need to have hedges in the portfolio, like commodities, commercial property and UK equities, which are proving resilient in these conditions.”

Michael Grady, Head of Investment Strategy at Aviva Investors, agreed: “The last monetary policy report from the Bank of England was quite extraordinary, and was, as far as I am aware, the first time that the Bank has got pretty close to forecasting a recession. It wasn’t quite there – but essentially, no growth next year, and a projection that sees inflation falling all the way back down to below the 2% target in 2-3 years’ time. Ultimately, this, in a time of rising interest rates is very, very unusual.”

Gareth Witcomb, Portfolio Manager in the Multi-Asset Solutions Team at J.P. Morgan Asset Management urged investors to remember that this is not isolated to the UK.

Witcomb said: “Inflation is a global headwind. We’re seeing rates creep up even in areas of the world where it has been traditionally difficult to generate inflation, like Europe and Japan.”

Structural headwinds to inflation are turning into tailwinds, claims Michael Grady, Head of Investment Strategy, Aviva Investors, who said: “Whether you think this trend started with Trump’s trade war and tariffs on China, Brexit, and, of course, the response from the international community to what is happening in Ukraine – these are all things that start to push structural headwinds in the other direction and lead to unintended consequences.”

Energy security

The energy security debate, sparked by the Russia/Ukraine situation, is also a key risk for investors, points out Michael Grady at Aviva Investors: “We have had the sanctions package from the EU announced towards Russian oil, but Russian gas remains available, and I think it’s unlikely it’ll be sanctioned as they’re simply too dependent and will be for too long.”

However - Europe is becoming more united, says Royal London’s Trevor Greetham

Greetham explained why investors should be more optimistic about the Eurozone, despite fears of a global recession and rising Italian and Greek sovereign bond spreads over Germany.

He said: “The war against Covid, the war against climate change and a new cold war with Russia are uniting Europe in a way which makes me more confident that the Eurozone will survive.

“There is a lot more centralised spending and burden sharing going on because of these common enemies. In the past when we’ve seen the risk of a recession investors start to wonder which country is going to break away first, but I believe this federalisation means the Eurozone will hold together.”

The panel then broke down in more depth how these risks might impact your portfolio as a private investor.

Where are the safe havens now?

J.P. Morgan Asset Management’s Gareth Witcomb told the panel:“The traditional safe havens, such as government bonds, just haven’t worked because of this inflation backdrop. However – if the market begins to worry more about growth, as well as inflation, we may see this correlation reassert itself. So perhaps, US treasuries might begin to look more interesting.”

Victoria Scholar, Head of Investment, interactive investor, added a point about cryptocurrencies, urging caution. She said: “Once hailed by some as so-called ‘digital gold’ – cryptocurrency has ended up being highly correlated to risk assets, in particular the NASDAQ and some of the tech stocks that have been struggling recently, and so I think crypto has lost its hedge-appeal for many investors as of late.”

The star of the show so far in 2022: commodities

Royal London’s Trevor Greetham outlined the opportunities for investors in the commodities market: "I have included commodities in multi asset funds for seventeen years. They were not all good years for commodities, and there were plenty of years where they were falling, but they give you great diversification. This is because they behave differently to equities, and have often given their strongest returns when equities have given their worst, as we’ve seen this year. Commodities are a safe haven in this sort of environment when inflation is overshooting.”

Greetham added: “At the moment, I would say broad commodity exposure is very useful. Due to the path to net zero, there is much less investment going into commodity capacity and demand is outstripping supply. If we get to the stage where Central Banks raise rates enough for ‘something to break’ and the world economy weakens, then gold could be a very good hedge for investors.”

Michael Grady of Aviva Investors pointed out, however, that “all of this is within the backdrop of a very weak China - the biggest consumer of commodities in the world. China’s zero-Covid policy has been a real challenge for them to continue with through the course of this year, but they appear to be sticking with it and this could create further periodic problems – this feels like an environment where we will not see a quick recovery in China. But if we see China emerging more strongly towards the end of the year, this could also help commodities, particularly as China is investing more in infrastructure.”

Greetham agreed, and added: “China’s easing policy has been so different to the rest of the world. You could even see a situation where the rest of the world is in slowdown, as they have raised rates enough to cool things down, but China is starting to pick up. It’s counter intuitive, but perhaps the emerging markets and China could become a safe haven in the next recession.”

J.P. Morgan Asset Management’s Gareth Witcomb gave another reason why China could look interesting in the future: “I can make a case that there are some tentative signs from the Chinese authorities that they want to try to pull back on some of the regulatory issues that were a concern last year – so maybe this is an area where, given where valuations are, this looks interesting from an investment perspective.

What does this mean for emerging markets more generally?

Despite being tentatively more positive on China, Witcomb added:“Looking at emerging markets more broadly, I am perhaps a little more cautious. Again, looking at political risk – one of the offshoots of the ongoing situation with Russia and Ukraine will be the disruption of food supplies which unfortunately is likely to affect emerging markets disproportionately, and this will have a large knock-on impact.”

Is the traditional ‘60:40’ dead? How can investors diversify in this challenging environment?

The panel of experts agreed on the importance of broad diversification, with inflation hedges in the mix. They all agreed that the traditional 60:40 portfolio (meaning 60% exposure to equities and 40% to bonds) is actually rather un-diversified, especially within today’s environment.

Michael Grady of Aviva Investors said: “The traditional 60:40 is now challenged. The reality is, if you look back to before 2000s, that correlation was the other way around. What’s worked fantastically for a long time has also been a more passive approach to investing, and this will also be challenged, going forward.

“Having the most unconstrained approach that you possibly can is something investors should always be looking at.”

Witcomb, however, pushed back slightly, saying: “Bonds have already readjusted, and although some may say that the 60% equities will largely be allocated to the US, I would argue that some of these US companies are secular winners here moving forward.” 

Ultimately, remain invested, says ii’s Head of Investment, Victoria Scholar urged investors not to react suddenly to intense moments of market panic.

She said:“There’s always a temptation to panic-sell at the first sign of a sell-off, but it can be extremely difficult to time market tops and market bottoms, and it’s also expensive coming in and out of the market.

“As we have discussed, there are a number of risks out there for investors, but you have to take a long-term approach and remain invested. You may even miss out when markets do, inevitably, bounce back!”

J.P. Morgan Asset Management’s Gareth Witcomb agreed with this sentiment, stating: “Markets have already moved. We’ve seen a 10-15% correction in equity markets and the data in the US, particularly, has been reasonable. So of course, there are legitimate reasons for retail investors to be slightly fearful of where the global economy is headed, but I would reiterate that markets have already adjusted and there are reasons to be optimistic. Be aware of the risks but it’s really about navigating them and, as Victoria, says, staying invested.”

The statements made during this event is not financial advice for ii customers and is for educational purposes only.

This event was hosted by part of ii’s Masterclass series. To find out more about ii’s events and webinars, see here:https://www.ii.co.uk/knowledge-centre/ii-masterclass.

The event was held on 8 June 2022.