For years prior to the Russia-Ukraine war, there were murmurs about deglobalization as geostrategic tensions grew, nationalism flared worldwide and the coronavirus pandemic stressed global supply chains, said Seth Weingram, senior vice-president and director of client advisory at Acadian Asset Management, during the Canadian Investment Review’s 2022 Risk Management Conference.
Since the invasion, that discussion has become much louder, he noted, amid speculation that the war could trigger a breakdown in globalization and, perhaps, the fragmentation of the world into strategic blocs. Although it’s difficult to predict how events might play out in the long term, Weingram argued that reglobalization — in other words, a change in globalization patterns — is more likely than deglobalization.
Pointing to a chart tracking the price of Russian oil relative to Brent crude, he noted that in the weeks after the invasion, Russian oil fell to a $30 discount to Brent as Western governments and refiners stopped buying it. That led China and India, two of the thirstiest oil importers in emerging markets, to step into the gap, buying Russian oil at a discount.
“This is a [clear] demonstration of the economics that give rise to and maintain globalization. It’s [also] a direct example of the crisis actually causing a change in globalization patterns — or reglobalization. Finally, if you think about it, does this example portend some kind of a strategic bloc forming between China, Russia and India? I doubt it. I think it’s better understood as three countries using globalized infrastructure to further their own economic interests.”
Using another chart marking the imposition of former President Donald Trump’s tariffs on China, Weingram showed the impact of those tariffs was fairly modest and short-lived, due to the emergence of the coronavirus pandemic and the subsequent economic recovery. Imports rebounded quickly, he noted. “This is another example of short-term economic incentives, trumping, so to speak, strategic policy objectives. So the takeaway from this is . . . we’re more likely to see reglobalization as an outcome of the crisis than we are deglobalization.”
Turning to the implications for institutional investors, Weingram said emerging markets, in aggregate, have become highly integrated with developed markets over the last several decades, a trend that reflects increasing trade integration, as well as mobility of information, capital and people. If globalization remains reasonably intact, investors may have to live with this kind of investing environment for the future, he added.
As a result, he suggested investors prioritize distinctiveness in their emerging markets investments to maximize the additivity to their opportunity set and portfolio diversification. “Think about focusing on the onshore China market, which is less well-integrated with other global markets. Think about focusing on [less well-integrated] segments of emerging markets — locally oriented companies, locally oriented stocks that tend to be less liquid, less efficiently priced than, say, high-flying mega caps — because emerging market strategies that lean into [the] large cap EM space, for example, may simply duplicate exposures and opportunities that you can get elsewhere.”
As for managing geopolitical event risk, when shocks hit, unless you have specific information about the nature of the event itself, the wisest course of action may be to stay the course, said Weingram, advising investors to focus on advance preparation as opposed to response.
Specifically, he suggested they focus on portfolio diversification, incorporate geopolitical risk into alpha models and not rely solely on backwards-looking risk management frameworks. “Geopolitical event risk tends to look a lot like idiosyncratic company specific risk, which should be diversified away. We see narrow, concentrated EM types of strategies coming into vogue periodically, but when local shocks hit, they can lose their appeal pretty darn fast.”
Weingram recommended institutional investors incorporate risk management guardrails into portfolio construction, starting with basic limits on individual position and country and sector exposures. They can also use scenario analysis to think holistically about how a portfolio might respond to certain triggering events, he noted. “From the standpoint of geopolitical event risk, don’t panic. Instead, prepare.”