Panel, Conference Presentation
Portfolio Strategies That Mitigate Political Risk
Milken InstituteRick Newman, Ellen Ellison, Marina Gross, Karen McQuiston, Alyssa Rieder, David Freeman, Marina Cooperman, Daniela, Martin Mlinar, Julie Siegel, Justin, Peter Barron, Eric Noel, Ruth Bader Ginsburg Jr.
- Political risk is shifting from a geography-based concept to a sentiment-driven, developed markets phenomenon involving the US and Europe, with expectations that while populist rhetoric may generate short-term volatility, institutional frameworks will likely maintain stability, as evidenced by post-election market gains of approximately 15% in the US and strong UK market performance following a temporary Brexit currency adjustment.
- Investors face a fundamental challenge as political risk involves binary, unpredictable outcomes that do not conform to traditional stochastic frameworks, with survey data indicating that 7 out of 10 investors believe political upheaval will not adversely affect results, though 10-year return expectations are constrained to low single digits based on current valuation levels.
- Portfolio strategies are adapting through increased allocations to global macro hedge funds, private equity, and 20% designated global macro risk hedges (including precious metals and natural resource equities) designed to perform during politically triggered distress while accepting potential underperformance during bullish market trends.
- Emerging market opportunities are being pursued in Latin America, with exposure upped to Brazilian agribusiness and real estate, driven by expectations of six of eight countries moving toward Western economic systems and the potential for the region to benefit if the US retreats from hemispheric trade, alongside selective investments in sovereign debt and private equity in Russia and China.
- Specific regional risks include a 51% vote for a presidential system in Turkey, potential authoritarianism from populism, and the "next two years" required for the UK to finalize Brexit details, while long-term drivers of populism such as income and asset disparity are expected to persist regardless of leadership changes.
- Investment horizons are critical in assessing risk, with comfort expressed for sub-Saharan African investments over 10-to-12-year vehicles to absorb currency drops, whereas direct South Korean investment has been declined due to geopolitical risk, and investors are utilizing financial technology to "x-ray" portfolios for currency and illiquidity exposure.
- Hedging political risk is considered counterproductive by some who argue investors should be compensated for assuming it, whereas others plan to measure tail risk ex-ante and apply data predicting policy change, expropriation, and corruption with greater confidence, noting that active investing is required to navigate these conditions rather than passive index funds.
- Market participants have reduced flexibility to manage emerging issues compared to previous decades, with concerns that rising inequality will exacerbate populism, while low oil prices are viewed as potentially masking underlying Middle Eastern geopolitical risks that should not be taken for granted.
- Specific corporate dislocations are already occurring, such as European software companies losing contracts and real estate shifts in London versus other European cities as organizations determine post-Brexit operational structures, even as the pound's 30% drop creates potential buying opportunities for endowments.
- The outlook suggests that while some US campaigned rhetoric may not fully materialize, the "willingness to step back" on hyperbole offers some relief, yet the possibility of other nations like China filling voids left by US policy remains a variable factor in global trading relationships.