White Papers

Don't Get Blindsided By Geopolitical Risks, Cautions UBS

Tom Burroughes Group Editor London 22 July 2010

Don't Get Blindsided By Geopolitical Risks, Cautions UBS

Geopolitical risks such as terrorism, war and trade conflicts have risen in recent years, which make it vital for investors to manage these uncertainties more effectively and minimise threats to their wealth, according to a white paper on the issue by UBS.

Events such as the 9/11 attacks on the US or Russian energy embargo against Ukraine in 2008/09 can “blindside” investors, although the effects of certain events can vary in magnitude and time, in some cases for many years, the Swiss firm said.

Among the risks highlighted are growing shifts in the balance of power – such as the rising economic clout of China – rising inequalities between some countries; declining support for free trade and rising military spending by some nations (China, for example), and growing state involvement in economies.

“We think geopolitical risk has increased substantially as a result of critical stress fractures in the world economy. The sources of stress exist over natural resource needs, national strategic ambitions, non-state ideological ambitions and income inequality,” UBS said in its 40-page report, called Geopolitics: the blind side.

The findings come at a time when wealth management strategists have devoted considerable time and commentary to wondering if the world economy could enter a double-dip recession, or whether growth will continue, albeit with some pauses.

UBS said it is concerned that geopolitics is still not well understood in an investment context. It highlighted a number of key conclusions:

-          Economic stress raises risk of geopolitical conflict;

-          Geopolitical events heavily influence long-term investment returns;

-          War has severe consequences for trade and affects neutral nations;

-          Some geopolitical events have temporary, reversible effects;

-          Terror attacks often have little financial market impact in the long run;

-          Some shocks, such as 9/11, have longer lasting structural effects;

-          Monitoring of global hotspots is important to limit financial exposure;

-          Geopolitics is another factor justifying diversification.

“The benefits of diversification have been touted for so long that their mere mention can make investors yawn. Yet we believe that geopolitical risks are precisely a topic for which diversification matters a great deal,” UBS said, while noting there are limits to how diverse a portfolio can be. For example, international crises can hit different countries, such as an energy shock or war.

Such risks can raise the issue of hedging, such as by purchasing out-of-the-money put options on certain currency and equity markets. This, UBS said, is a relatively cheap protection against market falls, but it warned that some shocks can hit the banks providing such derivatives.

In terms of tactical investing, crises can throw up opportunities caused when markets have moved fast, creating mis-pricings that can create arbitrage opportunities. For example, this can happen if the risk of government debt default is less than what is priced in by the market as a whole.

Register for WealthBriefing today

Gain access to regular and exclusive research on the global wealth management sector along with the opportunity to attend industry events such as exclusive invites to Breakfast Briefings and Summits in the major wealth management centres and industry leading awards programmes