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How geopolitical risk is impacting institutional investors

Dan Purves




Back in 2007, British Ministry of Defence research listed the middle class as one of eight risks to consider in strategic planning over a 30-year time horizon, as it posed a threat to the established order.

The DCDC Global Strategic Trends Program 2007-2036 predicted increasing economic and social volatility as a result of inequalities, acquired debt and the failure of pension provision, could trigger a rise in extremist politics. And while the immediate risk would be domestic, it would “ultimately fuel tension and difficulties at international levels.”

“The globalisation of labour markets and reducing levels of national welfare provision and employment could reduce peoples’ attachment to particular states. The growing gap between themselves and a small number of highly visible super-rich individuals, might fuel disillusion with meritocracy, while the growing urban under-classes are likely to pose an increasing threat to social order and stability,” said the report, headed up by Rear Admiral Chris Parry CBE.

While the Rear Admiral’s team did not know the details of how this might eventuate, the trend they identified found an outlet through Brexit, with a large bulk of those who voted to leave coming from the parts of society that had benefitted the least from a neo-liberal international political economy.

Numerous other reports, such as The State of Working America, from the Economic Policy Institute, have shown that while wealth globally has skyrocketed since the 1970s, the gains for most people have been at best marginal, and some sections have actually experienced a decrease in real terms.

Syriza party in Greece just ‘an early canary in the mine’

This has fuelled the growth of the disenfranchised across developed nation-station. From Syriza in Greece, to Le Pen in France, to senator Bernie Sanders and Trump in the USA. Those who have been left behind are uniting in support of voices that promise to attack the establishment that has so ill-served them.

“Since the GFC (global financial crisis) you [have] seen a lot of recrimination going back to established political parties; in other words, somebody is being blamed for the mess that the GFC has caused and the subsequent malaise that we are experiencing in economic conditions,” said John Eliopoulos, head of Australian equities and private equities at Telstra Super.

“The rise of populism is, in our opinion, likely to continue. We saw what happened with the Syriza party in Greece. That was just an early canary in the mine. I don’t think this is going to stop; I think it is going to continue.

“At the risk of sounding overly dramatic, in our lifetimes one of the more significant events that we could witness, is this rise of populist parties, and the backlash that we are experiencing against established or conservative political parties.”

The DCDC Global Strategic Trends Program 2007-2036 also spoke to this, stating that “the temptation to ‘strike back’ at perceived sources of disadvantage, while offering a return to earlier certainties will have particular appeal, and may spawn rejectionist, anarchist and nihilist groups and individuals”.

The politics of fear is on the ascent, demonstrated in the ugly nature of the debate, including the murder of the MP Jo Cox, in the lead up to Britain’s vote on whether to leave the EU. However, it is not a new phenomenon.

Hermann Goering, at the Nuremberg trials in April 1946, said: “The people can always be brought to the bidding of the leaders. That is easy. All you have to do is tell them they are being attacked and denounce the pacifists for lack of patriotism and exposing the country to danger. It works the same way in any country.”

Sands shifting beneath your feet

In response, geopolitics is becoming of increasing concern for people working in the superannuation system, with calls from people, such as Sunsuper’s economist Brian Parker, for it to be considered as a first-order risk.

There are two main reasons for this.

Firstly, most super funds have significant investments overseas, and instability in these regions poses a risk to returns from those investments. Even in the hypothetical situation where a super fund was only invested domestically, Australia’s economic fortunes are linked to the rest of the world and could suffer from events unfolding elsewhere.

Second is the systemic risk to the established international political economy from forces such as populism. All business and financial products are supported and sit in this wider system, so a shift here could have dramatic ramifications for superannuation.

Neo-liberalism has been the hegemony under which the world has operated for the past 40 years, with Francis Fukuyama famously claiming after the fall of the USSR that we were at the ‘end of history’ as there was no credible alterative ideas (he has since recanted).

However, one of the problems for superannuation funds and the wider established system is the rise of the ‘left behind’; a lot of resentful people who feel they are missing out and now have been mobilised through rabble rousers, who are able to harness that anger, says Keith Suter, a member of the global think tank, the Club of Rome.

Matthew Peter, chief economist at QIC, adds a situation has been set up through the economic pain sections of society are experiencing, where it is easier for populist politicians to portray other regions as trying to get an unfair advantage through the devaluation and manipulation of currency and “not having a fair playing ground”.

“All this type of talk, which we hear here in Australia as well, is one of the features of a post-GFC world. The very low yields and the resort to QE (quantitative easing)and that mechanism of effectively competitive exchange rate devaluation, plays into the hands of populist politicians,” Peter says.

The current system has left a lot of people disenfranchised, with many looking to hit back unless they experience change.

World-2-400x200“That makes for a very politically volatile situation domestically, and it means that governments are going to delay the progress towards globalisation, and therefore the global integration that we’ve been enjoying since 1945 may be slowing down somewhat,” Suter says.

He added the recent Australian election result gave more evidence of peoples’ disenchantment, with both Liberals and Labor acquiring the lowest number of primary votes since records began.

“We’ve now got identity-based politics which has emerged, rather than the old class based model, which makes life now even more complicated for politicians. Politicians are now entertainers and it means they are not going to be able to give attention to long-term issues, which is always my concern.”

He warned that superannuation funds should be watching, mindful of the backlash against globalisation, and possibly the further breakup of the European Union.

“The other thing is, will people get angry because they are putting so much money into super but they’re not getting the big results they are used too, because of the low-return investment world?” Suter says.

“That will add to the anger and the volatility of the electorate.

“We are moving into a society where older people have got the numbers. Baby Boomers in the 1960s were interested in sex, drugs and rock ‘n’ roll; we transformed society. Now we are more concerned about superannuation than sex, drugs and rock ‘n’ roll. And we are going to be very angry if it starts to not pan out the way that we hoped.”

As Richard Brandweiner points out in the equities article in the August print edition of Investment Magazine, super funds have significant power to shape the market and practices, in part through active engagement with businesses. This reshaping could potentially be used to create a more equitable system, and reduce the risk of a more revolutionary approach rising from the disenfranchised.

To combat against geopolitical risks, scenario planning repeatedly came up as the best strategy, as opposed to prediction or preferred outcome. Spending time outside of the superannuation community was also seen as an effective way to avoid epistemic risk.

“If you look at the banking crisis, for example, in the US leading up to 2008 you had a whole load of bankers who were just talking to other bankers,” Suter says.

“Meanwhile, you had people like Elizabeth Warren warning about it. Shiller at Yale was warning about it; the warning signs were all there. It was just that that epistemic community on Wall Street were not listening to outside voices, and so got taken by surprise.”