Geopolitical Risks And Me And You – Cash Is King
I read the Asiaone website when I need to feel safe and closeted from the world out there. The warm news of home, scandals and all, is comforting to that extent.
The main market moving news yesterday was Russia officially cutting off gas to Ukraine, along with the graphic videos of ISIS insurgents in Iraq massacring captured Iraqi soldiers. Those 2 were enough to keep crude prices at a 9 month high.
While we were riveted to the World Cup matches played last night, we had Argentina facing another credit crunch as the US Supreme Court ruled the country was to pay defaulted noteholders from 2001, in FULL.
Kenya plans to go ahead with a 2 bio eurobond offering even as Somalian terrorists invaded towns and killed 4 dozens Kenyans who could not answer questions about Islam.
Markets threw a hissy fit, selling off and looking shaky until more bad news saved it – IMF Cuts US Growth Outlook from 2.8% to 2% estimated in April which allows more scope for ZERO rates.
Because that is one thing we understand and geopolitics are just too complicated to be put into market prices.
Geopolitical risks cannot be modeled and that is the main reason why most of us are not covered for such risks in our insurance policies. It is probably the most murky component of what the risk department calls market risk.
War, terrorism, etc and even “unanticipated, unforeseeable and cataclysmic downward spiral of the world’s financial markets” does not count as force majeure.
Some financial models attempt to assign probabilities and circumvent losses arising from black swan, unprecedented, events. Most of those probabilities are based from history which does not usually repeat itself in its entirety.
So what we have, if you must know, is usually a group of important figures in an organisation like a bank, getting together for a lunch or coffee meeting in a nice boardroom, getting a few of the analysts in to present their views and then patting their stomachs to make a decision on whether Thailand is ok or Vietnam is fine, whether to reduce exposure to the region or to assign a higher probability of a market crash into the model (human intervention) and so forth.
For the individual, there is none of that because many of us are simply not trained to associate global macroscopic themes with our portfolios and our lives.
In the long run, crises even out when they erupt and Odds Are, It’s Gonna Be Alright, as the Barenaked Ladies sing.
The main difference between risk and reality is the waiting time between the two. Risk is the source of volatility while reality is the path of the future.
I believe that geopolitical risks are undermined these days by the power and clout of the central banks. Complacency has taken hold of investors as they look farther ahead past the current problems and assume that the present will be taken care of. Even banks do not go further than to hint delicately at global geopolitical tensions, hoping they would go away like they have done in recent years.
Instead of embarking into the subject of probability and studies on Kurtosis risk (a study of fat tails), I suggest the plain old common sense solution from investment legends like Sir John Templeton.
That cash is a distinct asset class that is not really correlated with anything else.
Yes. For all investors, big or small, cash is king as far as geopolitical risks are concerned.
But it is getting increasingly difficult to keep cash because even bank depositors are being used to bail out banks in Cyprus and just today, another piece of news that the Federal Reserve is considering charging fees to investors seeking to exit bond funds.
Cash is becoming a risk in itself because of the opportunity losses as asset prices continue to inflate globally. Investors are plunging into Bitcoins, gold and alternative asset classes like wine, art, stamps and such, to preserve their wealth yet those investments should be considered as a separate and illiquid asset class.
The typical allocation for a regular investment portfolio would be about 10% -15% in cash or cash equivalents which are usually in government treasury bills (SGD 6mths currently at 0.35%) or government bonds under 2 years in duration (SGD currently yielding 0.40%).
In hedging for geopolitical risks, the portion of cash could be raised to 20-30% while reducing the beta or higher risk equity and bond bets.
The other consideration is what type of cash ? Because keeping cash in IDR may not be a prudent choice especially for countries adversely impacted by external shocks i.e. countries with huge current account deficits.
USD is the usual suspect as is the SGD and the rest of the safe haven currency pairs.
Make no mistake that while we are reading all about the next World Cup match and who to place the bets on that the wheels in the investment world are turning. Bulky funds are reassigning their portfolio weights and deciding on their investment horizon based on all these new geopolitical developments.
The alternative would be just to plead ignorance and wait for the storm to come and pass.