In the current market environment, investors are hypersensitive to the volatility that external forces can bring to their investments.

Particularly, we are looking at the impact of major geopolitical events that could impact whole industries, economies and geographical regions. This is called event risk. Event risk is the risk an individual share or the overall share market suffers losses due to unforeseen circumstances. Event risk can impact a single company. For example, technological failures that recently impacted Optus. They can impact a sector, such as banning of marketing for cigarettes. They can also impact whole markets, like the breakout of an international conflict.

In the past, the global market events have caused short-term volatility in equity markets (below).

The impact of major global events, with short-term equity moves

The key geopolitical risks investors may need to navigate

Professor the Hon Gareth Evans was a previous Attorney General and Foreign Minister in the Hawke and Keating Labor governments. He is now a Distinguished Honorary Professor at the Australian National University, with his work focusing on foreign relations. He recently spoke at the Responsible Investment Association Conference (RIAA) on 1 May 2024. His keynote, titled ‘Navigating Geopolitics, Responsible Investors’ Risk in an Uncertain World’ described today’s world as ‘volatile and fragile’, and not just uncertain. He acknowledged that geopolitical events come in many different shapes and sizes, and that not all of them will cause a significant impact to portfolios and decision-making. However, he identified his top ten geopolitical risks that are most salient for Australian investors now and the near to mid-term future. They are not organized by the seriousness of their risk.

1. US – China Confrontation

The confrontation between these two states are top of mind for many Australian investors, as Australia’s push and pull between geographical proximity to China and historical allegiance to the West comes into play. Missteps in Australian policy or stance has resulted in crippling sanctions from China that have impacted Australian businesses in agriculture industries. The ban on coal imports erased over $1 billion dollars from Australia’s economy. This tightrope Australia walks on is heavily influenced by US-China relations.

Evans acknowledges that the US-China confrontation has eased considerably since the Biden-Xi summit at the end of 2023. However, there will continue to be a risk of escalation to violent confrontation between China and the US.

This will continue as long as the US ‘continues to assert, and China vigorously resist, its claim to both global and regional primacy’.

The prospect of all-out war has been overstated by much of the media, but there is a sore point – Taiwan. There is a risk that China will over-reach here, and a small incident could escalate into a crisis if it isn’t dealt with deft diplomatic hands.

What are the primary risks for Australian investors? Evans declares that the alliance with the United States will have consequences, especially if we are drawn into war. This will have an accompanying economic impact as China is our biggest trading partner by far. The sanctions and boycotts that have been imposed by China so far will seem negligible comparative to the potential boycotts.

Australian government policy is attempting to safeguard against this with the contested ‘Future Made in Australia’ policy. Reliance is an energy and national security issue as well as an economic issue. It is still unknown how far government policy and intervention can help this dire situation of reliance. However, the government’s stance is that it is not protectionist – it is instead the ‘new competition’ – and that it is keeping up with the rest of the world in hedging against this threat.

This scenario and risk are particularly elevated with a potential second term of a Trump presidency. We have seen that he does not own a pair of deft diplomatic hands. As investors, our exposure to China is intrinsic with investment in Australian equities. Evans thinks that ‘panicky disengagement’ from China does not make sense, but it is appropriate for investors to properly diversify their portfolios.

2. Russian Aggression

Russia’s invasion of Ukraine was the next geopolitical risk that Evans believes that Australian investors should be wary of. Although it has been over two years since the start of the war, the conflict has no end in sight. He states that it is the ‘most indefensibly naked act of cross-border aggression since World War II.’

Although most Australians do not have exposure to Russia, he believes that this is one of the cases where divestment from any exposure to Russia is hard to resist.

3. Nuclear War

The war in Ukraine is a reminder that the possibility of nuclear war continues. Putin has expressed his ability and propensity for nuclear weapon use which has not been expressed that strongly since the height of the Cold War. Evans also believes that when looking at China, North Korea and Iran, nuclear arms races in Northeast Asia and the Middle East is soberingly possible.

Evans does not think that there will be deliberate aggression with nuclear weapons. Instead, we need to be alert about the high possibility of human or system error, and miscalculation. Evans has long argued that is it nothing more than ‘sheer dumb luck’ that has prevented a nuclear holocaust over the last seven decades.

For investors, there are more concerning matters at hand in the event of a nuclear fallout than the positioning of their portfolio. In the case of nuclear weapons, Evans believes that a major nuclear exchange would be a threat to life as we know it. Responsible investors should think of the impact of investing in companies that have defence expenditures associated with the production of nuclear weapons. This is relevant to impact investors as opposed to investors that are looking to reduce risk in their portfolios.

4. Middle East meltdown

Evanss described the Middle East in his keynote as a tinderbox. Any one of a number of matches could set the situation alight. The consequences of this would include human and energy security, trade disruption and terrorism.

One large consideration would be refugee flows around the world into other areas. The implications for European, US and Australian economies would have to be considered. There would be destablisation of the region, inclusive of Europe and this would have flow on effects to the rest of the world. The impacts on the Australian equity market would be muted compared to what we might see with European markets.

Evans believes that the perspective in which investors should view the conflict should be from an ethical investment standpoint. It should be a consideration for those that are impact investors.

5. Climate inaction

I have written on the different between ESG and impact investing. However, climate inaction falls very much in both camps. Investors must consider it on the spectrum of risks when evaluating a company and their future prospects. Evans believe that the scale and gravity of the geopolitical challenges is colossal. In particular, energy security, human security and state survival for some in the Pacific region.

Investors must consider the financial and regulatory risks during the transition to cleaner economies.

6. Pandemic inaction

Evans believes it is important to prepare for the challenges of the repetition of a global pandemic, as there are far reaching consequences for economic growth and geopolitical stability. It is fresh in many Australian investors’ minds what can happen to companies that do not have healthy balance sheets and continue to harbour high debt-loads. We saw this particularly with airlines in Australia, where two airlines went into the pandemic and only one survived bankruptcy. Holding quality companies that have appropriate capital allocation policies protects portfolios.

7. Cyber Aggression

The cases of Optus, Medibank and Latitude Financial are fresh in investors’ minds. Cyberattacks on companies and governments are increasing. The advent and adoption of AI has sped this up for both political and criminal purposes.

This issue needs desperate attention and cooperation to manage across borders. Evans says that the message to investors is to simply be aware of the scale of the challenge. Many businesses will have to devote substantial resources to cyber defence, that will have financial impacts on margins and the bottom line.

8. Terrorism

There is a risk of renewed terrorist disruption. These are large events that are separate to the lone-wolf attacks that we’ve experienced in Sydney. Although the risk level is not high in Australia, terrorism can cause major system disruptions. It again is an issue that urges investors to be diversified, especially as we have seen many pre-retirees and retirees increase the aggressiveness of their portfolios to include riskier assets. 9/11 caused of the largest short-term losses for equity markets (shown in the above figure), and it is important that retirees are not forced to draw down upon slumped assets.

9. Major Human Rights Violations

Major human rights violations are generally not a concern or major risk for Australian investments. However, it is worth investors considering how binding sanctions or regulatory constraints could impact investments. This is particularly important for China as our economies are intrinsically linked. How geopolitical relations play out could have a direct impact on Australian businesses that conduct trade with China. Another future risk may be the growing relationship with India who Evans believes is under ‘ the increasingly authoritarian and anti-Muslim leadership of Narendra Modi.’ Australia is moving towards a relationship similar to what we have with China, where we are increasing trade relations and forging a security relationship.

10. Post-Conflict Peace building

The last risk that Evans goes into is more an opportunity, than it is a risk. There are many opportunities that come after geopolitical events for impact investors, and for traditional investors that are looking for opportunities. Volatility in markets after major events often results in investors turning nervousness into action and selling in and out of investments. Long-term investors staying the course can take a contrarian stance and take advantage of undervalued opportunities. Impact investors can take advantage of post-conflict peacebuilding. Evans suggests to those investors that they should explore mechanisms such as ‘blended finance and peace bonds’ that unite commercial capital with traditional government development assistance.

Final thoughts

Investors need to be aware of these risks and think about how their portfolio will respond to these issues. However, making wholesale changes based on what may happen borders on speculation. Take the opportunity to zoom out on the performance graph. Through all the market drops and rallies, there have been geopolitical events – minor and major. The market still trends upwards regardless of these events. Having high quality assets and an investment policy statement (IPS) that can provide clarity to investors in turbulent markets.