Despite the fact most geopolitical shocks can cause serious social and emotional damage, they have less of an impact on stock returns than many investors realize, according to Seth Weingram, senior vice-president and director of client advisory at Acadian Asset Management, during the Canadian Investment Review’s 2024 Investment Innovation Conference.
Indeed, when examining the market’s average response to 2,500 different geopolitical events, the average drop was very small, much less than one day’s worth of normal day-to-day volatility, he said. “And that’s what the market is actually pricing [the impact on expected earnings]. It doesn’t care about the emotional aspects of geopolitics, per se. It’s a pretty dispassionate place.”
Weingram cautioned against reflexively reacting to geopolitical events and, instead, suggested investors work to ensure processes can sustain a variety of circumstances. The market struggles with uncertainty, he said, adding that diversification can help, but there’s more investors can do to assess the risk in their portfolios. “In the words of [President-elect Donald Trump], ‘Let’s make investing boring again.'”
Geopolitical events, such as assassinations and coups, industrial disasters or civil disruptions, tend to be exogenous shocks that could, in unusual and very broad, multifaceted pathways, affect markets, he said. But trying to discern how all of those different factors are playing out in terms of the impact of an election on the full cross-section of thousands of stocks in a given region, is a daunting task.
“Many of the events that we’re talking about here — for example, assassinations, even elections — don’t last for a very long period of time. And the transience of those events also creates some significant problems relative to other risk phenomena, which we typically think of as lasting longer.”
Read: Institutional investors considering geopolitical risk, inflation in portfolio construction
Instead, Weingram suggested it would be more beneficial for investment managers to develop a risk profile that captures the potential impact of the geopolitical phenomenon in question.
Pointing to recent custom indices published by Goldman Sachs Group Inc., which were designed to track potential winners and losers from the Republican policy agenda, Weingram’s firm constructed an election equity factor to measure their portfolios’ overall exposure to that theme.
“So now we’ve got a basket that’s sensitive to the event, not so sensitive to the market, which is kind of intuitively what we’re trying to do. . . . What we’re talking about are tools that help us to understand risk in our portfolios associated with an event very well. But from the standpoint of a systematic investor, . . . we want to be very careful about intervening too much.”
Intervening in a systematic process has biases and costs that are associated with it, he added. “Don’t react reflexively. Let’s keep investing as boring as we can. We don’t want to be pressured into responding when events actually occur. . . .
Read: Which frontier markets are on institutional investors’ radars amid geopolitical churn?
“Despite some of the issues with conventional risk management toolkits, there are some things that we can do to really better understand the exposure that we have in our portfolios and I’d encourage people to think about some of those alternative methodologies.”
Read more coverage of the 2024 Investment Innovation Conference.