Some investors are “missing the point” of geopolitical risks by equating them to the disruptions from conflicts and wars, according to GIC chief economist Prakash Kannan, but in reality, geopolitical risk is no longer episodic or peripheral, but structural, persistent, and deeply intertwined with the functioning of global markets.
The actual geopolitical events are hard to forecast and consequently hard to be incorporated into asset allocation decisions, said Kannan, who is also director of the total portfolio strategy group, but he believes their impact on portfolio construction is more profound.
“It’s changing, I would say, almost the operating system of how we think about asset allocation,” he told the Fiduciary Investors Symposium in Singapore.
“You’ve all heard about companies not optimising for efficiency, but optimising for resiliency, but I think that’s actually been taken not just at the company level, but also at the level of the sovereign.
“Henry McVey from KKR has this nice phrase called ‘the security of everything’. I think that’s a central policy theme across a variety of countries. Everyone’s looking at the security of everything: energy supplies, critical minerals, and so on.”
This means three things for asset owners’ portfolios. For one, inflation will be a persistent risk as the world moves into an environment where supply shocks are more commonplace, Kannan said.
Secondly, investors can no longer take country composition as a “given”, meaning as a by-product of either following passive benchmarks or being led by bottom-up deal flows.
“The tendency is for most allocators to say, ‘Well, I care about assets, I care about deal selection, but then country mix is what it is’. But I think that’s got to change,” he said.
“Because if you’re moving to a world where country policy is going to matter a lot more, correlations across countries are going to go down. So how you think about country and FX risk becomes much more important going forward than it has been in the past.”
The final impact is that asset owners need to rethink how they aggregate geopolitical information across the organisation so that each staff members is not just accessing a fragment of the narrative.
“A lot of us are just not set up well to deal with geopolitics, meaning that we all read the same FT articles, but how do you synthesise that information? At GIC, we think about different ways where you get a dedicated team that helps curate information across a range of experts,” Kannan said.
“Firstly, you’ve got to figure out who the right experts are, add a layer of analysis to it, and then disseminate it to the organisation. If you don’t do that, you will find everyone kind of searching in the dark.”
Kannan outlined three imbalances in the current global investment environment: the US’ worsening fiscal situation, China’s external position, and capital concentration in the US.
The most likely mechanism through which the US fiscal imbalance can be resolved is higher inflation and US dollar depreciation, he said. The latter situation is less desirable for non-US dollar investors. He said that US policymakers are likely hoping to address the debt pressure through higher growth, yet whether AI can deliver the productivity miracle in the short term is still uncertain.
China’s large current account balance will most likely be neutralised through future outward direct investments and localising production abroad, or appreciation of the RMB, he said.
On the third imbalance identified, Kannan noted “There’s a lot of capital that’s concentrated in the US, which can resolve itself in a benign way if the rest of the world starts doing better, or it could get quite messy, particularly for the dollar.”
