Investors in the modern world lack comprehension of geopolitics’ repercussions

The writer is the CEO of Federated Hermes Limited.

Investors used to recognize the impact of geopolitics on financial volatility and economies. During the cold war, international tensions were evident through proxy wars and diplomacy. As a young boy living in East Jerusalem, I experienced one of these proxy wars first-hand in June 1967. This taught me the distinction between risk and volatility — the former carries the potential for complete loss.

The peak of this era occurred in 1973, a year that witnessed the US withdrawal from Vietnam and the outbreak of the Yom Kippur war, leading to an oil price crisis. Then in 1989, with the fall of the Berlin Wall, political scientist Francis Fukuyama declared the “end of history”.

Since then, there has been a widespread belief that globalization would diminish the influence of geopolitics on investments, except in developing economies on the fringes. However, the annexation of Ukraine by Russia last year reminded us of the central role geopolitics can play in investment decisions.

There were three key reasons why geopolitics took a back seat in investor frameworks. First, the collapse of the Soviet Union led to misplaced confidence in the spread of democratic politics worldwide. Second, there was a mistaken belief that the connected global economy was a new phenomenon, overlooking the long history of international trade. Third, it was believed that interconnectedness would eliminate conflict between nations and reduce geopolitical impact on the economy.

The transformation of China into an economic superpower fueled opportunities for investors and overshadowed rising rivalry with the US. However, China’s recent restriction on metal exports used for chipmaking, due to trade disputes with the US, serves as a reminder that economics and politics are intertwined.

Managers who can navigate geopolitical risks are best positioned to generate stable long-term returns. Failing to consider such risks could result in complete loss of clients’ investments, as seen with Russian assets following the invasion of Ukraine by President Vladimir Putin.

Today’s challenge for fund managers is to have an instinct for geopolitical risk despite lacking personal experience. Asset management firms should consider recruiting individuals with politics and history degrees to gain a diverse range of perspectives and expertise.

Geopolitical risk assessment is essential for both developed and developing markets, as seen with events like Britain’s Trussonomics episode and anti-police protests in France.

While considering the impact of monetary policy and economic and natural risks, it is crucial for investors to also factor in the influence of geopolitics. These factors are often interconnected, such as the potential for mass migrations triggered by ideological shifts or climate change.

As an investor, paying attention to geopolitical risks can be the deciding factor between securing returns or facing significant losses.