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How Does Geopolitics Affect Financial Markets?

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This article is sponsored by State Street Global Advisors.

In Alexandre Dumas’s 1844 novel The Count of Monte Cristo, news of an impending cross-border revolution in Spain leads to financial panic among French investors. Some investors end up selling Spanish bonds at a great loss, only to see the price bounce back after the news proves to be erroneous.

Geopolitics matters to markets in the real world too and has been a major theme in 2018, as the post-war global order is dismantled and protectionism takes hold. But, as in Dumas’ tale, it can be hard for investors to know how to react to such uncertainty. In this paper, we examine attempts to assess the impact of geopolitics on markets and conduct our own analysis on how it plays out over different time periods. Our hope is that investors can use this analysis when considering how best to respond to future geopolitical events, in terms of both the risks and opportunities they may present.

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Through the looking glass

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This article is sponsored by Dominion.

The decision taken by the British Government to require the 14 British Overseas Territories (BOTs) to establish Public registers of the beneficial owners of Companies registered in these territories has so far created a divided reaction. The BOTs, have generally taken the view that it is grossly unfair for the UK Government to use ancient Constitutional rights to impose the new legislation whereas the Crown Dependencies who are not affected by this decision have unsurprisingly provided a more measured response. This is reflected by Deputy Gavin St Pier in statements very similar to those issued by Politicians in Jersey stating that ‘Guernsey will introduce a public register if that becomes the agreed global standard.’

Gavin St Pier’s words have I am sure been chosen carefully since the body that has the necessary authority to end this debate is The Global Forum on Transparency and Exchange of Information for Tax Purposes (Global Forum) that has been the multinational framework within which work in the area of transparency and exchange of information has been carried out by both OECD and non-OECD economies since 2000. The Global Forum is the only international body endorsed by the G20 on issues of transparency and Exchange of Information for tax purposes.

So what does the Global Forum have to say on this issue. Well, paragraph 14 of the report of the Plenary Meeting of the Global Forum held in Cameroon in November 2017 states ‘The second round of peer reviews launched in 2016 reflects the latest developments in international tax transparency, including the requirement to have beneficial ownership information which strengthens the fight against anonymous shell companies and the use of legal arrangements to conceal ownership of identity.’ So reasonably one might expect, this issue should already have been dealt with. Unfortunately not it seems. The information sharing framework created by the Global Forum is designed as an exchange of information programme between Governments. Information exchanged is not available to the Public. So therein lies the problem. Public disclosure of beneficial ownership, despite what paragraph 14 might say, does not appear to have been clarified by the Global Forum, leaving it to Governments, pressure groups and other Organisations around the World to set the Public Agenda on this thorny subject.

Hopefully at this years Plenary Meeting of the Global Forum guidance will be provided on this issue that will feed through into legislation in all Countries that have adopted CRS. In the Plenary Meeting in Cameroon it was noted that ‘Some Members expressed concern that the ongoing EU listing process (referring to a proposed blacklisting of certain jurisdictions by the EU) is occurring outside the framework of the Global Forum… Statements like this would not I imagine encourage the Crown Dependencies to make further comment on this issue or to take any specific action as the Global Forum is clearly through these remarks reinforcing it’s mandate granted to it by the G20. The direction of travel, if one considers EU anti-money laundering Directives and bodies such as the EITI of which the UK is an important Member, would appear to favour a new regime creating a framework for Public Disclosure but when and in what form all stakeholders in this process will just have to wait and see what develops and whether the Global Forum will opine and then issue model legislation on this important issue.

To read more on this subject please visit: expertsinwealth.com/globalregisters

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How Do Public Pension Funds Invest?

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This article is sponsored by State Street.

Public Pension Funds (PPFs) are highly idiosyncratic and distinct from other types of institutional investors. The universe of investors that fall within our definition of a PPF is numerous and varied. We count 115 institutions in 70 jurisdictions, diverse in geography and economic development. For the purposes of our study, we examined the top 16 funds whose assets constitute just over two-thirds of the total universe. Despite all the idiosyncrasies of PPFs, we have found some shared characteristics in the evolution of their asset allocation over the past decade.

According to our definition, PPFs held around $5.9 trillion in total assets of 2016 and over 4% of all publicly traded assets, making them a significant global investor group. In particular, given their preferences for specific asset classes, their share is disproportionate in some segments. For example, we estimate that by year-end 2016, PPFs owned over 7% of global tradeable fixed income assets (including 8% government bonds and over 13% of inflation-linked bonds) and over 3% of listed public equities.

Similar to other asset owners, PPFs have undertaken a major reallocation of assets over the past decade. However, the motivating driver has not only been the low yield environment, but also changing regulatory and macro policy settings, which either permitted or encouraged greater diversification along asset classes and geographical exposure.

In detail, the most dominant trend has been the move away from holding domestic (local currency) bonds; in their place, PPFs have redeployed assets towards equities and alternatives, with a small share also diverted into foreign bonds. These allocation trends have been almost universal despite a huge diversity of geography and economic development.

It is important to acknowledge how much this investor group has changed over the past decade, with the asset pool growing by over 40% in dollar terms, and even more if measured in local currencies. While some funds are still predominantly captive buyers of government debt, the bulk of PPFs have been transforming into financial institutions with independent firepower and income-generating capacity. The long-term trend towards more diversified fixed income portfolios is likely to continue, as is the shift towards taking on more risk via equity allocations, subject as ever to changes in market cycles. In this context, we expect most PPFs to not only continue taking on more risk overall, but to further internationalise their portfolios.

Finally, one consideration is that maturing funds catering for aging populations will have to make further adjustments to their asset allocations to account for changing cash flow directions and seek greater contributions and investment returns to bridge any funding gaps.

All information has been obtained from sources believed to be reliable, but its accuracy is not guaranteed. There is no representation or warranty as to the current accuracy, reliability or completeness of, nor liability for, decisions based on such information and it should not be relied on as such.

This document may contain certain statements deemed to be forward-looking statements. All statements, other than historical facts, contained within this document that address activities, events or developments that SSGA expects, believes or anticipates will or may occur in the future are forward-looking statements. Please note that any such statements are not guarantees of any future performance and that actual results or developments may differ materially from those projected in the forward-looking statements.

Tracking Code: 2172159.1.1.GBL.RTL

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Authors
Elliot Hentov, Ph.D. Head of Policy and Research, Official Institutions Group Elliot_Hentov@ssga.com
Alexander Petrov Policy and Research, Official Institutions Group Alexander_Petrov@ssga.com
Sejal Odedra Business Analyst, Client Strategy, Official Institutions Group Sejal_Odedra@ssga.com

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The Slings and Arrows of Passive Fortune

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This article is sponsored by S&P DJI.

If a tale were to be written regaling us with the popular exploits of the modern day active manager in his quest for alpha across the many peaks and valleys of the financial world, passive investment would likely feature prominently in the telling. Passively managed assets have grown tremendously since their introduction in the 1970s to command some 20% of the U.S. stock’s market total-float adjusted capitalization, drawing a deluge of criticism in recent years from proponents of a more traditional, active approach who charge indexers with all manner of supposed ills – from encouraging collusive behavior and exacerbating pricing inefficiencies, to indifference on matters of corporate governance.

But are passive assets and their purveyors really the threat to markets that active management makes them out to be? Or are the problems attributed to their rise merely a reflection of the market forces all participants must face? These are the questions posed by Anu Ganti and Craig Lazzara at S&P Dow Jones Indices (S&P DJI) in their new paper, titled “The Slings and Arrows of Passive Fortune,” which seeks to unravel some of the most pervasive myths surrounding the growing role of index funds, highlight the immense value they bring to asset owners, and posits a future of asymmetric equilibrium between the old and the new that puts each in their proper place based on relative – rather than absolute – performance.

Nobody – including the paper’s authors – denies that index-based investment has made life more challenging for active managers, who count alpha as their very lifeblood; but so too would it be foolish to argue its advancement as one of the most important developments in modern financial history is without merit, or somehow Thucydidean in nature. If anything, active management can and should expect its portion of the pie (which, it must be pointed out, constitutes the majority of assets by a wide margin) to remain subject to nibbles from their passive counterparts – nibbles that may, with time, diminish. The market always has room for more players at the table, after all, and we all play by its rules.

As Director and Managing Director of index investment strategy team at S&P DJI, Ganti and Lazzara provide research and commentary on the firm’s entire product set – covering U.S. and global equities, commodities, fixed income, and economic indices. Both are chartered financial analysts and regular contributors to Indexology, S&P DJI’s appropriately named blog covering developments in the world of indexing.

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