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Future Fund warns geopolitical risk now dominant market force

Geopolitical risk is no longer a peripheral concern but a defining feature of the investment landscape, according to the Australian sovereign wealth fund's new position paper.
Future Fund warns geopolitical risk now dominant market force

The era of globalisation-fueled prosperity and relative geopolitical stability is over, according to Australia's A$223 billion ($149 billion) sovereign wealth fund.

The Future Fund, in a new position paper titled "Geopolitics: The Bedrock of the New Investment Order," argued that geopolitical risk is now the dominant force shaping market dynamics.

From the weaponisation of trade and the rise of strategic competition to the resurgence of populism and the increasing risk of conflict, the investment landscape is undergoing a seismic shift.

NAVIGATING GEOPOLITICS

"We believe that today, economic resilience is being prioritised over economic efficiency," Craig Thorburn, director of research & insights at the Future Fund, told AsianInvestor.

This shift, he said, "is leading to higher and stickier inflation, higher interest rates and increased correlation between listed equities and bonds."

The paper acknowledged that quantifying and predicting geopolitical risks is inherently difficult. 

Instead of attempting to precisely "measure" the risks, the fund advocates for a more dynamic approach focused on monitoring these trends and adapting portfolios accordingly. This approach requires a fundamental rethink of traditional diversification strategies, such as using government bonds to diversify equity risk, according to the fund.

Craig Thorburn,
Future Fund

The Future Fund itself has responded to these challenges by diversifying beyond traditional assets, increasing its allocation to alternative investments such as equity market-neutral and systematic macro strategies.

PORTFOLIO RESILIENCE

"Some of the actions we have taken include owning assets with strong characteristics that can pass-through inflation, for example infrastructure and commodities; rethinking our portfolio's asset and geographic diversification with a bias to domestic assets; and focusing on making our portfolio more flexible and associated investment decision-making more agile," said Thorburn. 

These strategies, he believes, offer the potential for uncorrelated returns and could help enhance portfolio resilience in the face of heightened geopolitical uncertainty.

The Future Fund's paper made one message clear: the relatively stable and predictable market conditions investors enjoyed for the past three decades are unlikely to ever return.

The sovereign wealth fund identified four key global trends reshaping the geopolitical landscape: changing trade dynamics, rising strategic competition, growing populism, and an increased risk of international conflict.

Governments have become increasingly focused on bolstering domestic production and securing supply chains, even at the cost of higher prices. This shift has been driven by a desire for self-sufficiency and reduced reliance on potential rivals. 

Also read: Future Fund's toll road deal shows desire for more local currency plays

"This active policy to bolster domestic manufacturing capabilities, especially in high-tech and advanced manufacturing sectors, has become a major initiative supported by developed and developing economies globally," the authors noted.

STRUCTURAL CHANGES

The Future Fund also suggested the world is undergoing a transition from a unipolar to a multipolar system, leading to heightened strategic competition, particularly between the US and China. The rivalry, fuelled by differing ideologies and economic models, may persist for decades, impacting resource allocation, technological development, and global alliances.

Escalating competition over resources and technology, along with "selective decoupling" in certain industries, will be justified in the name of national security, according to the paper.

Decoupling can manifest as tariffs, such as those imposed by the US and Europe on Chinese electric vehicles, or as outright bans, like the US restrictions on TikTok.

“We liken this behaviour to putting ‘sands in the gears’ of the flow of labour, goods and capital as economic efficiency takes a backseat. We are witnessing this through the recent tightening of foreign investment rules across the globe, as well as the use of tax subsidies to attract flows of capital into jurisdictions,” the authors wrote.

Meanwhile, growing populism, fuelled by economic inequality and distrust in traditional institutions, has moved the global system away from economic efficiency. These trends will continue to result in policy gridlock, protectionist measures, and heightened global tensions as nations prioritise domestic interests over international cooperation, the fund predicted.

The paper observed that "policy choices like tariffs or industrial subsidies are as much about political populism as they are about economic resilience."

The decline of US hegemony and the rise of other powers like China and India create a more fragmented geopolitical landscape, increasing the risk of global instability. 

"This creates an interesting juncture where, to sustain the post WWII era of globalisation and US-led multilateral co-operation, other nations may need to play a stronger hand or risk the world segregating into pockets of alliances, creating more disharmony and conflict," the fund suggested.

According to the Future Fund, these long-term structural changes will continue to reshape the investment landscape, necessitating a re-evaluation of international cooperation to avert further fragmentation and discord.

¬ Haymarket Media Limited. All rights reserved.
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