How to Protect Your Investment Portfolio from Geopolitical Risks?

“When America sneezes, the world catches cold”, goes a famous saying. 

Every country in the world is always susceptible to socio-economic and geo-political factors happening around the globe, and we aren’t an exception either. In recent years, India has faced several geopolitical challenges, including enduring conflicts with Pakistan, rising tensions with China, The Russia-Ukraine crisis, and so on. Not just these conflicts, these risks also arise from a variety of sources including changes in government policies, natural disasters, and other economic developments. These events have created increased volatility and uncertainty in financial markets.

But should we be concerned about all these developments? How do we navigate through these rough seas? Let’s discuss this in detail.

Table of Contents:

1.) Stage 1 –How have we fared financially in the past?
2.) Stage 2-Russia- Ukraine War.
3.) Stage 3-The Covid Crisis.
4.) Stage 4-Good time for financial investments.
5.) Stage 5: New Avenues of Investment.
6.) How to Mitigate These Risks?

• Don’t put all your eggs in the same basket
• Proper Asset allocation
• Continue Investing
• Country-based investing- The Theory of Correlation

 7. )Bottomline

How have we fared financially in the past?

Before we start discussing how to mitigate and safeguard our Investment Portfolio, we will first see how we as a nation have reacted to some of the geopolitical risks in the recent past. 

Russia- Ukraine War:

It all started in late Feb 2022 when Russia was premeditating attacks on Ukraine to annex them and replace the government. The Russian president ordered the annexure of Ukraine on Feb 24, 2022, and the whole of the world reacted sharply to this news. 

30 countries-imposed sanctions against Russia, cutting energy imports, blocking financial transactions, and halting shipments of key imports, such as semiconductors and other electronics. Russia in turn retaliated by imposing sanctions on those countries by enforcing a blanket ban on food imports from Australia, Canada, Norway, Japan, the United States, and the EU. This led to the collapse of the Russian currency and worsened the economic impact caused by the war.

Indian stock market fell by around 5% on Feb 24 on account of the war breaking out. There was a frenzy in the stock market and the index was making lower lows for the next 2 weeks. This changed on the 10th of March 2022. The Indian market started reversing kick-starting a mini-rally that lasted for a month.

Even today the war is continuing, but the impact from the perspective of this conflict seems to have been consumed by the economy.

The Covid Crisis:

We all know how Covid wreaked havoc in our lives in 2020. Every single human being’s life all around the globe was thrown out on order as we had to safeguard ourselves from the deadly Coronavirus. The GDP of all the countries barring China nosedived.

Image Courtesy: Businesstoday.in

According to CEIC, India’s economic growth was down by 23.9 % as compared to its previous YOY growth. This was the worst fall in India’s economic history. Many of us have made mistakes by selling our Investment Portfolios and anticipating further drawdowns, isn’t it?

But did we not recover from this? Yes, we not only recovered from this huge fall but went on to make new highs.

To put things into perspective, we lost ~40% of our wealth in about 3 odd months and gained around 147% in the next 2 years. 

These above 2 examples are pretty recent ones that one can think of where we went haywire and then recovered quickly. On a global scale, we do see many geo-political things happening. Some of the other geopolitical issues include the 2008 Lehmann group crisis, Brexit and Demonetization in 2016, the 9/11 terror attacks in the US in 2001, the Kargil war in 1999, etc. 

In all these events, we as a nation were beaten down but we managed to overcome those and create new heights.

Ok, now that we have seen we overcome all such economic crises, do you know these instances can be made beneficial for retail investors like us?

Good time for financial investments:

In all the previous examples we saw how our economy rebounded from the lows. These are levels that come once in a blue moon. They present good opportunities for people who had missed out on investing earlier. 

By large, the fundamentals haven’t changed and all the volatility and drawdowns are because of the geopolitical risks. So, for a long-term investor like us, we should cash in on every such opportunity. You can very well average your stocks or get more units in your mutual funds.

New Avenues of Investment:

Every major geopolitical risk paves way for newer reforms and policies in the country. Take for instance India in the 1990s and the famous China +1 narrative post-Covid. In the 1990s globalization and liberalization happened and that is precisely when our economy opened up and started to gather pace.

Similarly post Covid, India adopted the China +1 narrative where the plan was to reduce its dependencies on China for some of the imports in Pharma and the electronic segments. This created a thrust for Indian companies and helps build a more resilient and less vulnerable to geo-political risks. As retail investors, if we can manage to spot such companies in the early stages, we can make a good return over a longer term. 

How to Mitigate These Risks?

Well, no strategy can fully eliminate geopolitical risk. It is important to approach financial investments with a long-term perspective and an understanding of the inherent risks and uncertainties involved.

Some of how we can face these financial uncertainties with a soft cushion effect can be seen below:

• Don’t put all your eggs in the same basket:

When you get started on your investment journey, you would have been advised to not invest everything into a single entity. Suffering a loss in one investment could erase all the wealth you have built up. Diversify yourself into different asset classes and within the same asset class as well. You can read  one of our similar blogs on portfolio diversification to understand more about this.

• Proper Asset allocation:

Asset allocation is the process of dividing an investment portfolio among different asset categories such as;

• Stocks.
• Bonds.
• Real estate.
• Commodities.
• Cash taking into account the tenure and the nature of your financial goal. 

The purpose of asset allocation is to balance risk and reward by diversifying investments across different asset classes.

Consider you are following goal-based financial planning and that you are nearing one of your financial goal’s maturity. By this time all your investments should be in short-term debt funds. This eliminates the immediate jerks in the markets and safeguards your capital.

When your goal is more than 5 years ahead, you can invest in Equity Funds. Even if you face a major catastrophic event, you will still have time to recover financially.

Live Mint publishes the Asset quality quilt every year on the best and worst performing assets. Have a check for yourself and see why asset allocation is most important in alleviating geopolitical risks.

• Continue Investing:

Systematic Investment Plans (SIP). SIPs help in mitigating all such unforeseen financial circumstances. You needn’t worry about what the market situation is. If the markets are going higher, then your financial investments are growing with the help of the accumulated units. Just in case it is a bear market; you get to accumulate units at lower prices. This helps you to generate a sufficient corpus by end of your tenure.

SIP is designed for long-term financial investment and encourages investors to focus on their long-term financial goals rather than short-term market fluctuations. This helps to reduce the impact of short-term market volatility and potentially improve overall returns to the investor.

• Country-based investing- The Theory of Correlation:

Correlation is a statistical measure that indicates the extent to which two or more variables move about each other. In investing, correlation is used to understand the relationship or assumed rate of return between different instruments. We should always consider investment instruments having negative correlations as the alternative investment, as this can help us ride the volatility wave and improve the performance of our investment portfolio. 

Choosing a negatively correlated instrument for mitigating the Geopolitical risks leads us to a whole new set of investing called International investing/County based investing.

One can consider investing in an investment instrument that invests in a different county just for the sole reason of diversification. For retailers like us, there are a plethora of investment opportunities as well. We have many direct and funds of funds operated from India that invests directly in these entities. 

You can simply invest in their index funds (E.g., S&P 500 Index fund or Nasdaq 100 funds) to reduce the concentration in your investment portfolio. Having an exposure of 5-10% in international funds is considered smart as there isn’t much impact on one’s portfolio.

On the flip side, these international investments also have their demerits. As an informed investor you should study all the possibilities and only then invest.

 Bottomline:

Geopolitical events can have a major effect on the financial markets and global economy, presenting challenges for retail investors like us. When we invest for a longer period, there will certainly be some sort of events that keep happening in the world economy which may result in crashes. Time and again we have witnessed that the markets recover and continue scaling heights. 

There is no point in worrying about such risks and neither there should be any worry in our minds as to what to do just in case we face these complex geopolitical landscapes. We should follow these risk mitigation techniques to build a resilient portfolio to withstand all these geopolitical risks and economic shocks. 

If you need some guidance on building a diversified portfolio that can withstand geopolitical economic risks, it would be helpful to consult with your financial advisor before investing.