By the time Nick Chamie graduated with his first degree in economics in 1992, the Berlin Wall had already fallen and the Soviet Union had ceased to exist.
Still, Chamie — now the chief strategist and senior managing director at the Investment Management Corp. of Ontario — explains that, as he began making his way in the financial industry, the long shadow cast by the Cold War kept geopolitics front and centre in the minds of key decision-makers at many of the world’s largest institutional investors.
“Since the early ‘90s, [geopolitics] had fallen to the wayside considerably and, instead, almost purely economic or business considerations were the overwhelming, dominant decision drivers,” he says.
“But in recent years, particularly over the last two or three years, [geopolitics] has roared back. That takes various forms: sometimes it’s thought of as a driver of returns and other times, as a driver of investment risks, but it’s certainly an important factor right now.”
Aaron Bennett, chief investment officer at the University Pension Plan, says global affairs have been virtually impossible to ignore since the UPP’s official launch as a multi-employer, jointly sponsored pension plan in the summer of 2021.
“It seems like we’ve moved out of this period of relative calm where there was lots of synchronized global growth. We’re a defined benefit pension, so we have the ability to focus long term and be proactive, but at the same time, we have to respond to short-term factors and make sure that we are using our tools and the lens of geopolitics to monitor and manage the volatility that can happen.”
A growing concern
Bennett and Chamie aren’t the only investment professionals paying close attention as the creaks and vibrations of geopolitical tectonics tick upwards in volume.
“The whole geopolitical issue tends to go in cycles in terms of how much it weighs on the industry and I’d say it’s at the strongest level I’ve seen in many years,” says Sonia Baxendale, president and chief executive officer at the Global Risk Institute.
In the 2023 edition of the organization’s annual Canadian financial services risk outlook survey, geopolitics made the top five list of the most prominent threats currently worrying many of the top financial institutions in the country, including banks, Crown corporations, pension funds and asset managers.
It was early 2020, just before the start of the coronavirus pandemic, when geopolitics was last mentioned as a top concern in the GRI’s flagship survey.
However, Baxendale says geopolitics could become a fixture of future editions of the survey, as increasingly strained relations among the world’s superpowers fuel concerns about supply chain disruption, energy security, inflation and trade disputes.
“Even other key risks, such as those related to the climate and artificial intelligence, are becoming highly politicized, so they get interwoven into this geopolitical discussion, too. I think there are direct impacts to business and indirect ones in terms of unintended consequences that ultimately mean you have to care about it from an investment perspective.”
Taking a long-term view
Despite the prominence of geopolitical tensions, Kristina Hooper, chief global market strategist at Invesco Ltd., is wary of overstating their effect.
As long as institutional investors develop an asset allocation process focused on achieving a well-diversified portfolio and long-term investment goals, it may be worth “almost putting on blinders,” she says, to minimize the distraction from flare-ups that will inevitably occur in various parts of the world.
“Most of the sentiment resulting from geopolitical issues doesn’t have much of an impact, certainly over the longer term. We have faced a lot of risks over time and yet, even with what I would say is a very, very real threat — the Cuban Missile Crisis, as one example — there has been this gravitational pull of stocks over the long term upward.”
Whatever their views on the long-term impact of geopolitical factors, most institutional investors seem united on the catalyst of this recent resurgence: the Russian war in Ukraine.
Almost two years on from the invasion, Bennett laments the normalization of a conflict that has gradually become part of the furniture of global politics. “It’s unfortunate, because there are real people involved in a very serious situation and — to a certain extent — it does seem to have fallen out of the headlines.”
Below the surface, the economic shock waves of Russia’s attack will continue to reverberate, as uncertainty over food and energy supplies interferes with central banks’ attempts to bring inflation under control. In addition, the corporate flight from Russia could signal a more fundamental shift in global finance, he says. According to a Yale University project, more than 1,000 major companies have already voluntarily curtailed their operations in Russia beyond the level required by international sanctions. And Canadian institutional investors — the Alberta Investment Management Corp. and the Ontario Pension Board, for example — promised to divest their portfolios of existing Russian assets in the weeks following the invasion.
“As time goes on, maybe shareholders will want back in after the situation resolves,” says Bennett. “But on the other hand, there will be some who look and say, ‘We don’t think it’s an investable market.’ From a macroeconomic point of view, this has changed the way people think about doing business in countries like Russia.”
For many observers, the next most obvious global flashpoint is in the South China Sea, where longstanding territorial disputes — including the possibility of a Chinese invasion of Taiwan — could put the world’s superpowers on a collision course.
Jia Wang, interim director of the University of Alberta’s China Institute, remains hopeful that international cooperation can take some of the heat out of the situation.
But in the meantime, she says Canadian investors have a particular interest in China’s status on the world stage, thanks to the singularly poor relations between the two nations. “If you compare China’s relations with G7 allies, every other country — including the U.S. — is doing better than Canada.”
Following a brief respite in 2021 prompted by the release of detained Canadians Michael Kovrig and Michael Spavor, bilateral relations spiraled even further downwards over the spring and summer of 2023, when the countries engaged in tit-for-tat diplomatic expulsions during a row over foreign interference. The immediate prospects for a diplomatic thaw don’t look good: in September, the federal government initiated a public inquiry that’s likely to focus on leaked intelligence reports that allege China attempted to influence Canadian elections.
“Canada-China relations are sometimes described as fraught or strained, neither of which are very positive terms,” says Wang. “I’d characterize the relationship as being at the lowest point since diplomatic ties were established. As we know, many of the large institutional investors are under pressure, including from Parliament, to examine their investments in the Chinese markets.”
According to Baxendale, any Canadian financial institutions with Chinese holdings should be reviewing their relationships there. “Some have pulled back, others have not. Each situation is a little different and they’ve really got to evaluate the strategic implications,” she says, noting investment decisions will ultimately depend on several factors, including the materiality of China to institutional investors’ operations and the potential for reputational damage arising from associations with alleged human rights abuses against the Uyghur people.
“I think we’re going to see strategic pullbacks, rather than more substantial, across-the-board exits — at least for now. But of course, that can change.”
A Chinese retreat seems to be in the cards for a number of Canada’s largest pension investors. During Parliamentary hearings held earlier this year, executives with the British Columbia Investment Management Corp. and the Ontario Teachers’ Pension Plan told legislators that changes to the risk landscape in China had prompted them to pause future direct private investments in the country.
At the same legislative committee, a senior managing director at the Canada Pension Plan Investment Board revealed Chinese investments accounted for almost 10 per cent of the plan’s total assets, followed soon after by news reports claiming both the CPPIB and the Caisse de dépôt et placement du Québec had scaled back the private equity teams in their Chinese offices.
The IMCO has assembled its Chinese assets with flexibility in mind. “Illiquid investment is off the table for us,” says Chamie. “We want to be careful to make sure our exposure there is liquid so we are able to adjust it as developments unfold and as our viewpoint evolves.”
While some commentators have been unconvinced by China’s post-pandemic reopening, raising broader economic concerns about its housing market and youth unemployment levels, Hooper remains relatively bullish. “I think of China as an interesting opportunity because sentiment is so negative, because it’s been so beaten down. If we were to see any kind of policy stimulus, that would have a positive impact on Chinese equities, because they are priced for a rather negative scenario, which is the antithesis of being priced for perfection.
“If we take a step back and look at it in terms of diversification, it’s important to have exposure to a wide variety of foreign regions and asset classes and the Chinese economy is not a minor economy that can be easily ignored.”
Risk and opportunity
As Chinese and Russian assets become less attractive, Bennett says it’s important for investors to remember the flip side of the risk coin.
“With volatility and uncertainty comes risk, but it also creates opportunities for other regions and industries. When you think about some of the supply chains coming out of China, there are areas where countries like Vietnam, Thailand and Indonesia can benefit, although these are smaller markets and that is something you have to be cognizant of. On the more developed side, we’re seeing Singapore increasingly considered a business hub, even more so than it was in the past.”
India is one of the countries best positioned to capitalize on the struggles of other emerging markets, he notes. “They’ve had a huge digital transformation and have shown an openness to foreign investment.” However, it remains to be seen whether Canadian investors will still be as welcome after trade-deal talks broke down amid allegations of Indian state involvement in the recent murder of Canadian Sikh leader Hardeep Singh Nijjar in Surrey, B.C.
Events like this latest diplomatic crisis highlight the core challenge for institutional investors attempting to incorporate geopolitical factors into their decision-making, says Yusuke Khan, a partner and investments leader for Canada at Mercer.
“Trying to predict political action is bound to be messy. Things can change very quickly, which is why you want to have as many levers as possible in your portfolio, by ensuring that you are exposed to different countries in different regions at different points in their economic cycles. This is not the time to give up on diversification.”
Michael McKiernan is a freelance writer.
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