Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 293

How populism heightens portfolio risk

Around the world, political leaders are finding success selling deceptively simple answers to difficult questions, using the failings of free trade and mass migration as a convenient whipping boy for rising inequality.

Giving a voice to people’s frustration is one thing, but addressing the cumulative long-term effects of privatisation, de-regulation, corruption and technological change that have silently eroded the economic rights of the individual is another. Investors need to be aware of this.

A global economy flush with cheap capital has not helped, generating asset price inflation to the glee of the wealthy and accelerating a boom in skill-biased technological innovation. Arguably, it is the failure of policy makers to equip their labour forces with the skills of the future that has been the most profound contributor to the growing angst around wealth differentials.

Equal opportunity and unequal reward

The real question for policy makers is how to return opportunity to the people, with the societies that prove more resilient being the ones that can afford to balance the need for equal opportunity with unequal reward.

What matters for investors is that populist policies almost always result in looser fiscal policy, often at the expense of productivity-enhancing structural reform with negative short-term social consequences.

The euro area is a case in point. Following the European sovereign crisis, the European Central Bank embarked on an asset purchasing programme to create a more favourable environment for unleashing market mechanisms in Europe’s rigid economies and bloated welfare systems. It was a precondition for steady and balanced growth. The short-term impact of fiscal austerity, for example, created socio-political problems of rising unemployment and falling state revenues. It created a policy outcome no euro area government had a mandate for. Witness the social turmoil and political changes in Greece, France, Italy, Spain and Portugal as these countries experienced a powerful pushback to labour reform and austerity.

The rise of populism across Europe has also been accompanied by a surge in tensions between autonomists and centralisers, with the potential to further exacerbate fiscal risks. Interestingly, this trend is not a reaction to economic woes, being most pronounced in Europe’s most successful regions. Northern Italy, the wealthiest part of the country, has long flirted with the idea of floating off to form a country called Padania. Catalonia, the most productive part of Spain, has been fighting for independence to cut its payments to poorer Andalusians. The continent’s integration was meant to solve such questions, but they are surfacing once more to the angst of Europe’s leaders.

Not even the United Kingdom, where the House of Commons plays the role of one of the oldest representative institutions on Earth, has been immune to the spread of populism. Britain has succumbed to the populist wave because it decided to apply the most powerful tool in the populist toolbox – the referendum – to the most profound question regarding its relationship with its main political and economic partner. While the visible result has been the re-shaping of British politics by 'Brexiteers' claiming that the people have spoken, the less visible result has been a constitutional revolution. Before the referendum, Parliament reflected the best interests of the sovereign. Now, for the first time in Britain’s parliamentary history, MP’s feel obliged to give in to a populist revolution.

Recent events in Italy are a timely reminder that populism, fiscal policies, bank balance sheets and lending to the private sector are inextricably linked.

Through rising yields, bond markets sanction any perception of unsound fiscal policies likely to aggravate budget deficits and public debt, or in the case of the euro area, violate commitments to deficit and debt targets. Rising bond yields shrink the value of bank assets which consist of large holdings of government bonds, in turn making banks more risk averse and less inclined to extend credit to the private sector.

With Trump’s populist policies seeking to widen US fiscal deficits to levels last seen in times of war or recession, markets may soon begin to discount the US government’s EM like sovereign risk profile and increasingly limited fiscal firepower.

With the populist locomotive now set in motion, increasing political risks have the potential to stress nations that have rapidly accumulated both public and private debt, reliant on external capital despite weaker institutional frameworks.

Set against the backdrop of tighter global monetary liquidity and the potential for slower growth and higher inflation, the financial and political tail risks are elevated.

Recent overindulgence

A decade of overindulgence has led to another set of risks. As generationally-low interest rates and QE-induced yield curve flattening has throttled excess capital towards increasingly risky financial assets, investors have been willing to pay a premium for the illusion of durability in an uncertain world.

The bubble in ‘structural’ growth is perhaps the most poignant example. Technology products and their suppliers have changed the world, making up a higher proportion of global market capitalisation than ever before (globalisation has been a conduit for even greater industry concentration and risk).

Tending to dominate their early niches, businesses such as the FAANNGM’s (an ever-expanding acronym), Alibaba and Tencent have generated tremendous value protected by deep competitive moats.

In search for further growth, investors are investing in their competitors. Whether it’s Amazon and Netflix competing on content streaming or Amazon’s Alexa threatening Google’s core search business with its voice search capabilities, the titans are bumping heads.

For competing software and internet businesses, barriers to entry are being eroded. The ability to deploy, then effortlessly scale their technology on platforms offered by Amazon Web Services, Microsoft Azure and Google Cloud reduces up-front capital expenditure. Combined with large addressable markets and a boom in cheap venture capital funding, particularly in the US and China, the seeds for intensifying competition have been sown. The next frontier of technological disruption won’t be so easily won.

Preparing for uncertainty

The challenge with the current environment is the number of low probability, but potentially material, events that are difficult to build a portfolio around.

Accordingly, over the long-term, we believe that a holistic framework for managing uncertainty is likely to prevail. At the position level, we seek to own attractively priced businesses with a margin of safety and investment resilience, characterised by multiple ways of winning.

Looking beyond the more simplistic model of regional or sector diversification, our investments are grouped into clusters that share overlapping sentiment, idiosyncratic, end-market and macro sensitivities. As stocks within clusters are likely to exhibit a higher correlation to each other, we limit cluster sizes to no more than 15% of the portfolio while attempting to minimise the correlation between clusters. In this sense we aim to control, to a higher degree, concentration risk within the portfolio and mitigate the impact of the unknown unknowns. We also employ multiple levers, such as longs, shorts, active currency and cash management, to offset building portfolio risk.

 

Jacob Mitchell is Founder and Chief Investment Officer of active global equity investment manager Antipodes Partners. This article is general information and does not consider the circumstances of any investor.

RELATED ARTICLES

Why not use options to protect your share portfolio?

What does the 'fear gauge' VIX really mean?

10 rules of thumb for investing during uncertainty

banner

Most viewed in recent weeks

Three steps to planning your spending in retirement

What happens when a superannuation expert sets up his own retirement portfolio using decades of knowledge? He finds he can afford much more investment risk in his portfolio than conventional thinking suggests.

Five stock recoveries not hanging on COVID predictions

The focus on predicting the recovery from the pandemic is the wrong emphasis. Better to identify great companies benefitting from market changes over a three- to five-year horizon with or without COVID.

Peak to peak, which LIC managers performed during COVID?

A comprehensive review of dozens of LICs shows how they performed in the crucial 'peak to peak' of COVID. This 14 months tested the mettle and strategies of a sector often under fire, with many strong results.

Finding sustainable dividend stocks on the ASX

There is a small universe of companies on the ASX which are reliable dividend payers over five years, are fairly valued and are classified as ‘negligible’ or ‘low’ on both ESG risk and carbon risk.

Blink and you missed a seismic shift in these stocks

Blink and it happened. If announcements in this sector were made by a producer of iron ore, gas, copper or some new tech, the news would have been splashed across the front pages. Have we witnessed a major change?

How inflation impacts different types of investments

A comprehensive study of the impact of inflation on returns from different assets over the past 120 years. The high returns in recent years are due to low inflation and falling rates but this ‘sweet spot’ is ending.

Latest Updates

Shares

Platinum’s four guiding investment principles

Buying mispriced stocks is often uncomfortable when companies are outside the spotlight and markets are driven by emotions. And it's inescapable that the price paid ultimately determines the end result.

Interviews

Andrew Lockhart on corporate loans as an income alternative

Loans to corporates were the traditional domain of banks, but as investors look for income alternatives to term deposits, funds have combined hundreds of loans into a single structure to create a diversified investment.

Retirement

10 things I learned in my faux-retirement

Pre-retirees should ‘trial run’ their retirements. All those things you want to do - play golf, time with the family, a hobby, write a book - might not be so appealing in reality, but you might discover other benefits.

Retirement

Achieving a sufficient retirement income portfolio

Retirees require a reliable income stream to replace the wages they received when they were working and should focus on the dollar income generated over time rather than the headline yield percentage.

'Wealth of Experience' podcast and ASA webinar on ETFs v LICs

Peter reveals some top stock picks with an emphasis on long-term assets like Sydney Airport, Graham discusses spending in retirement and valuing assets, the key to Amazon, guest Andrew Lockhart and plenty more.

Strategy

Lucy Turnbull’s three lessons on leadership and successful careers

From promoting women to boost culture to taking opportunities as they arise, Lucy Turnbull AO says markets should not drive decision-making and leaders must live and breathe the company's mission and values.

Economy

Are concerns about inflation inflated?

While REITs and some value stocks are considered 'inflation-sensitive' assets, the data provide little support that they are good inflation hedges, and energy stocks and commodities are too volatile. So what works?

Sponsors

Alliances

© 2021 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. Any general advice or ‘regulated financial advice’ under New Zealand law has been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892) and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. For more information refer to our Financial Services Guide (AU) and Financial Advice Provider Disclosure Statement (NZ). You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.

Website Development by Master Publisher.