Investment portfolios are now highly globalized – and that means investors must factor geopolitical risks into their decision-making process. So said Edouard Senechal, Senior Analyst, dynamic Allocation Strategies Team at William Blair during his presentation, titled “Macro diversification: navigating the Geopolitical Landscape.” As investors learn to navigate an environment marked by short-term volatility, geopolitics has become important – understanding the risks involved can help explain why prices differ from fundamental value and where there are opportunities for investors, said Senechal.
This is where game theory comes in handy, he added, noting that it can help investors gain an understanding of the geopolitical landscape by analyzing the strategic interactions of multiple rational players working towards the best possible outcome in a given situation.
Considerations for understanding the role geopolitics plays in investments are: who are the primary players, what are their objectives, what are their bargaining powers and what are the implications?
Senechal explained that, in future, geopolitics will become increasingly relevant in the context of investment decisions because of the rise of populist governments and the tough economic future facing developed countries. As he noted, since 2008, governments around the world have faced unprecedented economic challenges. And, while growth has recovered since the depths of the recession, the output gap in major developed countries has been exacerbated by adverse demographic trends. As Senechal noted, economic growth is linked to population growth and in the developed world, the baby boomers are retiring and the population is shrinking. “if your population doesn’t grow, it’s a lot harder for your economy to grow,” he said.
High debt-to-GDP levels in developed countries are also a factor: governments have less room to maneuver and policy decisions will likely have immediate financial consequences
Pay attention to politics
“We have to pay attention as an investor to those decisions and how they come about,” Senechal said, using Greece as an example. Last year’s bailout debates between Greece and the European Union showed investors that political turmoil can easily cause market turmoil. And while Greece is not very relevant from a financial value standpoint, the market reaction to its political situation can create volatility.
investors who understand and consider this can take advance steps to hedge against this risk.
“The problem with politics is that, even more than economics, these are the types of conversations where everyone can argue both sides of the same point.” Senechal concluded. That is why having a framework like… game theory can be beneficial to help investors navigate geopolitics, organize information, focus attention and plan accordingly.
“What we try to do is to instill a process so that we can quantify our opinion and come to rigorous conclusions from this process.”