Is your portfolio designed to weather the new geopolitical era?
The difference between risk and uncertainty might sound subtle, but it is not. Risk relates to things we can quantify based on a reasonable data sample size, whereas uncertainty is about things that cannot be quantified. Geopolitical events are inherently about uncertainty and have a wide range of unknown outcomes.
The picture that has emerged since Russia invaded Ukraine in 2022 is that of a war economy, especially for Europe, with the natural outcome of fiscal expansion and likely persistent inflation. Trade policies are also part of a changing geopolitical landscape, and tariffs and industrial policy will increase in importance over time.
What should investors consider to weather the future?
Asset allocation was easy over the past 40 years of falling bond yields, stable geopolitics, positive demographics, no climate disasters, and low inflation. But going forward, the astute investor will need to take the changing world into consideration.
Could investors not simply remain 100% in equities and hope history repeats itself? Given the emerging picture of structural breaks in our global economy, this would be naive.
Below are a few things that investors should consider to strengthen their portfolio in the era of the war economy and negative demographic trends. In essence, the suggestions below deviate from the traditional 60/40 portfolio (60% in equities and 40% in long-term bonds). We are not providing portfolio weights to each category, as each investor is different.
- Equity themes:
- Semiconductors/AI, as this technology will be a determining factor for power in the future.
- Defence, because Europe has a significant deficit in military capabilities and new technologies to address drone swarms are necessary.
- Cybersecurity, because this is the new key operating system for any government or company.
- Renewable energy, because from a national security point of view there is less risk. Renewable energy has no fuelling source and the energy assets can be spread out in a more decentralised way.
- Equity sectors: The four most attractive long-term sectors right now strategically are 1) healthcare, 2) technology, 3) financials, and 4) energy. These sectors have the best probability with the information we have today to deliver strong real returns over the next 10 years.
- Gold: Gold has historically been a good diversifying component in times of war and inflation.
- Commodities: All severe inflation shocks have been associated with rapidly rising commodity prices, so an allocation to commodities makes sense for the war economy and to hedge against inflation. The green transformation could also trigger sustained trends in key commodities, including copper.
- Short-term and inflation-protected bonds: Inflation-protected bonds are worth considering, as these bonds get their principal value increased in line with the official CPI. Short-term bonds create optionality and basically act like cash, as they have limited duration and are thus less risky amid greater inflation uncertainty.
