Revolutions in Tunisia and Yemen, violent protests in Bahrain, unrest in Syria and a stunning regime collapse in Egypt. An earthquake, followed by a tsunami, followed by a near-meltdown of a nuclear reactor in Japan. And, of course, a civil war in Libya that's slowly dragging Western forces into yet another armed conflict.
Combine all those events, cram them into the space of six weeks or so, and you have the recipe for massive investor unease. Add the what-ifs to the list and the geopolitical context in which advisors have to manage client portfolios-and keep those clients calm and focused on long-term objectives as well as short-term risks-becomes even more complex.
"The potential linkage between geopolitical events and the financial markets is far more significant and relevant to investors today than at any time in the last 20 years," argues Marg Franklin, CEO of Toronto-based Kinsale Private Wealth. Franklin, who also chairs the board of governors of the CFA Institute, attributes this to everything from the headlines about the seismic changes rocking the Middle East to political spats in Western nations about oversize debt.
All of these issues, she says, can be lumped together under the broad heading of geopolitics; all these geopolitical concerns have at least the potential to threaten the stability of the economic system and throw the best-laid financial plans into chaos. To keep their clients on the right track, advisors must know how to find the delicate balance between concern and action, and adjust portfolios and strategies without overreacting.
THE RIGHT BALANCE
On a superficial level, most advisors are positioned to address geopolitical issues. They know the importance of being well-informed about the headlines of the day and the topics about which a client may demand answers; they know to seek out analysis of the ways in which the multiple catastrophes that hit Japan may derail everything from supplies of computer components and Toyotas while boosting sales from rival South Korean or Chinese firms. They know that unrest in the Middle East shows up almost instantly in the price of crude oil, and that there are trading opportunities to identify.
This is only part of the story, however, suggests Hans Olsen, chief investment officer of J.P. Morgan Private Wealth Management in New York. "There is a temptation in turbulent periods like this to overreact; many events, however catastrophic, end up not changing the business cycle all that much."
But advisors need to know the right balance to strike. It's easy to discount political upheavals in countries like Egypt, Libya or Nigeria as a sideshow to the global economy. In fact, these and other nations have become far more linked to others amid constant globalization.
Moreover, Olsen points out, there are flash points in markets that investors and their advisors tend to think of as being more stable. For example, last year's unrest in Greece and other parts of the European Union stoked anxieties about that group's ability to cope with a debt crisis in countries on its periphery.
Other potential headaches aren't even on the radar screens of most investors-yet. For instance, few investors are fretting about what might happen after the death of Bhumibol Adulyadej, Thailand's elderly and ailing monarch. Given that the king plays a crucial, unifying role in Thai society-and that his heir (the king's son, Prince Maha Vajiralongkorn) doesn't command the same respect-the potential for a flare-up certainly exists.
All of these considerations are enough to give planners an oversize migraine. Keeping track of these events is one issue; trying to keep ahead of the curve is another. "These are the kinds of events that don't fit into mathematical models," says Tina Fordham, senior political analyst at Citi Private Bank. That can lead investors to try to discount them-particularly given that, historically, even world-altering events like the 9/11 attacks have had relatively short-lived impacts on market volatility and economic growth.
That's a mistake, Fordham argues. "A world awash in liquidity is more easily able to shrug off big geopolitical events, but that's no longer the environment in which all these events are occurring."
These difficulties are one reason that advisors like Greg Olsen, a partner at New York-based Lenox Advisors, which manages about $1.3 billion in assets, is turning increasingly to alternative investments, including managed futures products. "When a trend takes shape, a managed futures fund is best positioned to capitalize on that trend," he says. The managers of these funds don't care what the event is that produced the trend; they are more intent on trying to stay ahead of the curve and hop on board the next trend if momentum shows signs of faltering.
Olsen also ponders geopolitical issues in everyday investment decisions, such as his views on gold (he's bullish) and how best to profit from the run in oil prices. "Russia is perfectly poised to profit from rising energy prices, but Russian energy companies have to cope with an unpredictable and heavy-handed government involvement in business," he points out. Olsen prefers to stick to U.S.-based multinational companies that rely on global markets for their growth.
Of course, no advisor can keep up with all of the political and business consequences of every development around the planet. But there are some strategies that most planners can follow to make dealing with geopolitics easier.
* Identify trends, not risks. It's too simplistic to develop a list of the top 10 risks, Fordham argues. What's more important is identifying trends that will become important in shaping a government's policies or demands of a country's citizens. That could range from watching the evolution of the Tea Party movement in the U.S. to the powerful demographic changes in the Middle East.
Anyone monitoring the growth of an educated youthful population with few job prospects in a politically corrupt nation like Egypt might have been better prepared to understand, digest and explain to clients the context for that revolution. Understanding what trend lies beneath a headline-grabbing event also reassures clients that an advisor understands what's going on and can distinguish between events that need to be addressed in a portfolio and those that will simply cause short-term volatility and only require monitoring.
* Don't overreact. Selling Japanese stocks might have been a logical initial reaction to the March earthquake, but it might not be the right one. The full consequences of the explosions at the nuclear plants aren't yet known, but what is certain is that there will be decades of rebuilding required, from homes, schools and businesses to highways and power plants. That could translate into an uptick in corporate profits in Japan, and for companies doing business there.
Similarly, it's hard to resist the tendency to chase rising oil prices amid the developments in the Middle East. But traders are veterans when it comes to dealing with shifts in market sentiment, and advisors know the dangers of trying to go up against skilled hedge fund pros. A $10 move in the price of a barrel of oil in reaction to a rumor or an event can vanish even more rapidly than it appeared.
* Ensure you're being paid to take geopolitical risks. Too often, the allure of high growth rates blinds investors and their advisors to the risks they are taking. Just because it's hard to model geopolitical risks doesn't mean an advisor can't reflect on what risks exist and compare those to expected returns.
For instance, while China looks like a model of stability compared with the Middle East, it also has a totalitarian government that must cope with the demands of a young, educated population. Is the risk, however small, of a popular upheaval in China reflected in clients' portfolios?
* Buy insurance when you don't need it. The last year has reminded advisors and clients that geopolitical events are among the least predictable of all those that can roil markets and affect their returns. Whether it is last year's Greek debt drama or this year's wave of political revolt in the Middle East, few anticipated the magnitude of the changes.
"It's easier to be proactive than reactive," says Matt Freund, senior vice president of USAA, a San Antonio mutual funds group. That doesn't mean trying to predict what will happen, just expecting that something will happen to unsettle the markets. He suggests keeping core holdings in assets that are likely to be resilient in all but the most catastrophic events, or that will recover most rapidly, such as shares of firms that pay huge dividends and have strong balance sheets.
* Stash some cash. In volatile times, there are plenty of opportunities to buy stocks at a discount. Just ask those investors who were willing to invest in oil companies late last spring, in the aftermath of the BP oil disaster in the Gulf of Mexico.
"Anyone with cash is going to be paid for providing liquidity to markets that are selling off," Freund says. Whether it's selling crude oil futures at the peak or buying uranium mining stocks post-nuclear meltdown, every crisis generates an opportunity for advisors whose clients have the cash to put to work and who have done the due diligence in advance.
* Look behind the scenes. The drama this year has centered on big political changes in countries like Egypt, with revolutions occurring in days or weeks. But one of the legacies of the financial crisis has been the growing role of the state in the economy and financial markets of developed economies-a geopolitical trend of great significance.
One Boston-based planner who asked not to be named admitted that his best decision for his clients in the last 12 months was his conclusion that the Federal Reserve would remain committed to quantitative easing and that this would succeed in buoying the U.S. economy to a greater extent than many experts anticipated. "We did pick the right stocks, true, but it would have been easy to underestimate the extent to which the Fed was involved in markets," the advisor says.
Similarly, Fordham points to a series of pending regional elections in Germany. Individually, their results aren't likely to make the front page of The New York Times, but collectively they will determine the extent to which Germany is willing to continue bailing out the rest of the European Union-and thus the fate of that economic bloc.
* Think about how you communicate with clients. Dwarfing all other considerations is how an advisor discusses the latest headlines with his or her clients. "These can be dramatic events, but clients need to realize that you have structured their portfolios to meet longer-term objectives; they need to be reassured that there are some things in those portfolios that are stable in a world that appears to be in flux," Fordham says.
The biggest challenge may be resisting client demands for quick and certain answers to what happens next in the wake of dramatic events that no one anticipated. For instance, when it comes to Egypt-a country with no real "civil society"-it might be tempting to draw analogies between the kinds of popular revolts that unseated communist regimes in Eastern and Central Europe. But this kind of comparison is flawed.
Instead, Franklin suggests, bring the discussion back to the client's portfolio. "Make the conversation about what is in that portfolio, and why, for instance, the Middle East drama is another reason, besides having a hedge against inflation, to have an overweight position in commodities. Just because the television networks offer instant answers doesn't mean that a financial advisor should follow suit."
Suzanne McGee is a New York-based freelance writer and the author of Chasing Goldman Sachs.