Changing trade dynamics, a rise in strategic competition and growing populism have made it crucial for investors to consider geopolitics in portfolio construction, according to the Future Fund, Melbourne.
The sovereign wealth fund, which had A$223 billion ($143.2 billion) in assets as of March 31, published its third position paper on June 28 titled ‘Geopolitics: the bedrock of the new investment order’.
But geopolitics does not refer solely to conflicts or the risk of conflict, Craig Thorburn, director of research and insights and lead author of the paper, said in a phone interview.
“A lot of people fall into this view that when they’re talking about geopolitics, they actually talk about conflict. What we’re trying to do with this paper is to be a lot more nuanced in trying to get people to understand that, at least in our view, there is much more to geopolitics,” he said.
The paper outlined four main trends — of which the risk of conflicts is one — that have made geopolitics “a more relevant frictional influence” today and in the future compared to the preceding three years.
Changing trade dynamics, for instance, can be observed through the onshoring or friend-shoring of manufacturing facilities, particularly in critical industries such as semiconductors.
The world order is also shifting from unipolar to bipolar, and potentially multipolar in the future, which leads to rising competition over natural resources and technology, and selective decoupling from certain industries such as electric vehicles or companies for instance in social media. The paper also highlighted that the fund was keeping an eye on currency interventions as a possible guise of strategic competition.
Growing populism in all parts of the world could lead to greater polarization and, combined with new communication channels such as social media and artificial intelligence that have led to the spread of misinformation, could also lead to acute and chronic political instability, the paper wrote.
Lastly, the increasing risk of conflict is a consideration for investors, which the fund has observed for years since the great financial crisis, as the U.S. drew back on its hegemony.
“The first paper was done towards the end of 2021. But we actually did the work internally in May 2021. So we presented that work, (which you now know) as The New Investment Order, that was actually presented to our board in May 2021. And we talked about those types of futures or that possibility, even back then,” Thorburn said.
At that point, major conflicts such as the Russia-Ukraine war and in the Middle East had not yet escalated, but all the other themes had become noticeable enough that the team thought it was worth spending the time looking at the trajectory of the trends, he said.
The paper also highlighted a series of actions that the wealth fund has taken to build resilience in the portfolio in light of these themes. For instance, to address the first three trends, the fund leans towards a bias to own more assets that can outperform in an inflationary environment, domestic assets, energy transition assets, private equity in the technology sector, and alternatives with greater diversifying characteristics.
To address the increasing risk of conflict, the fund also plans to add exposure to gold, commodities, and different regional and currency allocations.
In 2023, the fund made A$60 billion of changes across all asset classes in the portfolio to build resilience after the launch of its first two papers published in 2021 and 2022, according to its 2023 Year in Review report.
For instance, the fund shifted back to active management in listed equities with a focus on small-cap equities in Australia to seek more alpha in a higher interest rate market. The fund also reduced exposure to China due to increased intervention in certain market sectors and challenges to the country’s economic growth model, while seeking more domestic assets to find regional differentiation in its portfolio, which included energy transition opportunities, the report wrote.
Future Fund had 10.1% of its portfolio in Australian equities, 27.1% in global equities, 15% in private equity, 5.7% in property, 9.5% in infrastructure and timberland, 11% in credit, 14.7% in alternatives and 6.8% in cash as of March 31.
