ART cautions against ‘false positives’ in analysing geopolitical risks

Last month, the Australian sovereign wealth fund identified geopolitics as fundamental to a new investment paradigm, noting that it has made the 60:40 portfolio largely redundant; however, for the Australian Retirement Trust (ART), geopolitics is an “interesting” consideration, one that it’s more inclined to prepare for than to predict. 

The fund, which manages close to $300 billion in retirement savings for over 2.3 million members, has grappled with to what extent geopolitics should impact the design of its portfolios.

Speaking to Super Review, ART’s head of investment strategy Andrew Fisher said: “I think, for us, it’s not been something that we’ve seen as an area of competitive edge, where we think we can systematically add value to the portfolio, by using geopolitical insights, to improve our portfolio design.

“What we have tended to do with geopolitical risk is, rather than trying to treat it as something that we can predict, [we’re] seeing it as something we can prepare for and then respond to if an event occurs.”

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Fisher is particularly worried about “false positives”, which could negatively impact portfolios if pursued impulsively.

“There are a lot of stories, a lot of news, a lot of things that might happen, but there’s an enormous number of false positives. You’ve got to be careful not to react in a systematic way, because chances are, you are going to detriment portfolios by reacting to those false positives,” he said.

In its latest position paper, the Future Fund said geopolitics will profoundly impact financial markets, macro-economics, and policy decisions. This, the fund said, is giving it cause to refresh how it invests to continue to achieve its investment purpose. 

One of its primary strategies involves a renewed commitment to diversification across geographies and asset classes, driven by the shifting dynamics of high inflation and interest rates that have pushed the equity-bond correlation into more positive territory.

However, the sovereign wealth fund said that geopolitics is often a “misunderstood risk” and that effectively interpreting geopolitics while also managing a risk-seeking investment portfolio is “exceptionally challenging”.

At ART, an investment resilience and planning team is tasked with stress-testing certain scenarios and jumping on opportunities arising from market uncertainty. 

“It’s very hard to predict when a geopolitical event is going to happen and one of the things we try to do is, even when the scenario is being thought through, the first thing to work out is what is the actual economic impact that this geopolitical event might have. And if it doesn’t have a particularly sizable likely economic impact it’s probably something we shouldn’t need to worry about too much,” Fisher said. 

“What we would then do is focus on looking for market overreaction, and perhaps taking opportunities to provide liquidity when markets overreact to things we don’t think are as big an issue.

“We do a lot of scenario and stress testing analysis, but really, we’re going to focus on – if this stress event were to happen, what would we do next, rather than how do we stop the stress event from hurting the portfolio.”

He said that, while it’s “nearly impossible” to avoid a drawdown in a high growth portfolio, the best way the fund can enhance and deliver better outcomes is to be poised to provide liquidity to markets.

“For us it’s thinking about making sure we have adequate liquidity across the portfolio, liquidity management is a very important part of that investment resilience and planning team focuses on,” Fisher said. 

The investment executive said that often, with a top-down strategy, individual assets “don’t always roll up to what you expected” and it’s for the investment resilience and planning team to pinpoint the unintended risks and outcomes. 

“When you’re building portfolios, you can’t sort of sit and say ‘I’ve got this right’, always try and work out where things have changed, and things are always changing and how can you continuously improve the portfolio,” Fisher said.   

For the $233 billion Future Fund, heightened risks have been a primary driver behind its shift away from the traditional 60:40 investment portfolio. Instead, one of its primary strategies has involved a renewed commitment to diversification across geographies and asset classes. 

“Instead of relying solely on government bonds for that much-needed diversification – as per traditional portfolio construction – we are turning to more true diversifiers in our portfolio: exposures that come from non-directional alternative/hedge fund strategies such as equity market-neutral or systematic macro strategies, for example,” the sovereign wealth fund said.

Currently, its position includes owning gold and commodities, more domestic assets, and different currency and regional allocations.

“Geopolitics results from the nexus of geographic factors, policy decisions and cultural norms – the rules, risks and opportunities by which economies operate – and its impact on economies and financial markets has been a reality for investors for generations,” it said.

“We believe it is likely to remain so for generations to come.”