Markets so far shrugging off daily dose of global surprises

Terrorism. Brexit. Cyberattacks. North Korea's missile tests. A special prosecutor investigating the U.S. administration's possible collusion with Russia.

It appears the world is becoming increasingly unpredictable and volatile.

“Geopolitical risk has always been right underneath the surface. But things seem to be bubbling up to the surface more so now than they have in the last 10 years,” said Rob Balkema, senior portfolio manager, multiasset solutions, for Russell Investments, New York.

So, how do investors navigate the minefield of geopolitical risks inherent to global investing? Most industry insiders say although asset owners are becoming more concerned with geopolitical risks, it's essential to tell the difference between one-off events and events that could mark long-term change.

And for the most part, they say, the events are one-off events.

Most geopolitical events have a very short-term and transitory impact on markets, Jim McDonald, chief investment strategist for Chicago-based Northern Trust Asset Management, said in a phone interview. After a major geopolitical event, the market on average initially loses about 4%, but only a few days later goes back to doing whatever it was before, he said.

“So, there's a high bar for us to make a change (to portfolios) because of a geopolitical event,” said Mr. McDonald.

Alexander Kazan, managing director, global strategy and analytics at global political risk research and consulting firm Eurasia Group, New York, agreed. “It could be a North Korean missile test or a terrorist attack, where there's a very quick reaction in the market,” said Mr. Kazan. “But typically, these one-off events tend not to have a sustained impact on markets.

Mr. Kazan noted “there are exceptions — 9/11, of course.”

More interconnected

Northern Trust's Mr. McDonald suggested the reason some events have such little lasting impact on markets is because the world's economic system is more interconnected today.

Christopher A. Levell, partner, client strategy for NEPC LLC, Boston, concurred. “We're all very interconnected,” he said. “That interconnectedness means there's a strong incentive for even bad actors to meet their commitments.”

Mr. McDonald added another reason one-off events tend to not impact markets long term is because investors today get the news faster about geopolitical events and what they could mean to markets than in previous decades.

Jamie Lewin, head of product strategy and performance management, BNY Mellon Investment Management, New York, said geopolitical risks “are failing to nudge these longer-standing concerns investors have, such as growth and the path to interest rate normalization. They're failing to pervade markets.”

For example, hotspots in the Middle East are becoming less influential on energy prices than in the past, he said.

Like many other managers, BNY Mellon is trying to assess how and when a political issue becomes an economic one. “Growing tension in Asia and conflict between North Korea and South Korea do keep investors awake at night, but it's tough to figure out how this affects their portfolios,” said Mr. Lewin.

Mr. Lewin cited the U.K.'s vote to leave the European Union as an event that can be translated into economic terms that could change how investors manage their portfolios.

Brexit “has implications for value of currencies; it has implications for trade,” he said. The event can also be converted into a series of forecasts for what it could mean for companies trading in Europe that might no longer enjoy the open borders to which they've been accustomed.

Still, Mr. Lewin has had more discussions about geopolitical risk and macroeconomics with clients now than ever before. “(Clients are) wondering about the U.S.' role in the world, something that investors have never had to think about to this degree before,” he said.

One way for asset owners to mitigate the risks inherent to global investing is to simply diversify their investment portfolios.

“They should remain cautious and even develop a plan around what they might do if there's a thing they're concerned about. But I think the best response is staying diversified and having that capacity for redeploying capital,” said NEPC's Mr. Levell.

Heeding diversification

Celia Dallas, chief investment strategist at Cambridge Associates LLC, Arlington, Va., also mentioned the importance of clients diversifying their portfolios in the face of escalating geopolitical risk.

“It is not possible to anticipate or predict geopolitical risk,” said Ms. Dallas. “Predicting what the outcome will specifically be is treacherous as we all saw in the Brexit vote and in the election of Donald Trump, where the market reaction was not expected on Wall Street.”

Added Ms. Dallas: “You need a dose of humility, diversification and enough ballast and liquidity in your portfolio to meet your portfolio's needs. This is something investors should always be doing and the uncertainty of geopolitical risk is yet another reason why.”

Eurasia Group's Mr. Kazan explained that long-term, institutional investors are best to either ignore one-off events or see them as opportunities to add to positions if that event doesn't fundamentally change that investment's underlying thesis.

Still, he said, it's important investors understand “the strategic shifts in the geopolitical order that are going to have a lasting impact on redirecting patterns of trade and investment.”

There are a few areas in which institutional investors should pay extra attention to politics.

One area is emerging markets. Investors should understand where political stability is eroding in such markets to the point where it will affect investment fundamentals in the region.

Another area to pay special attention to politics is from a risk management perspective: “Understanding where geopolitical hotspots are and understanding where things are heating up into something potentially more serious,” added Mr. Kazan.