In the week since ‘Liberation Day’, and the mounting of prolific and many large tariffs, markets have witnessed volatility not seen for five years.
The VIX, a popular measure of the stock market’s expectation of volatility, closed on Monday up 209 per cent on a year ago, a five-year high. In the past 20 years it has only been higher two other times, October 31, 2008 and March 20, 2020.
While some of the success of American capitalism in the past has been due to the process of creative destruction, it hasn’t typically been at this scale, or inside government, observes Andrew Palmer, CIO of Maryland’s state retirement fund.
“It definitely reduces confidence,” he says in relation to the volatility in markets. “It is going to impact the behaviour of consumers, businesses and investors, just because of the uncertainty.”
In Palmer’s state, where there is a high concentration of federal government jobs, he says there is already anecdotal evidence of waning retail and traffic activity on the streets.
A bigger concern according to Palmer is a potential seismic shift among long-term investors to retreat from a US-concentrated portfolio.
“The bigger picture is that we have gone through a decade or more where the US has been the destination of choice for capital – that might be unwinding. There is a lot of money that is still here that might decide to go home,” he says.
“This is undoing the benefits of diversification because it’s forcing investors and business to be more geographically focused so that [diversification] utility is not there. So we may have to lower return expectations or accept higher risk.”
The dollar question
Others reflect that although the impact of tariffs is very distracting in the short term, a much longer-term issue is also in play around the future role of the dollar in global commerce.
“Tariffs feel like a short-term issue we can likely look through; longer-term I am focused on whether this signals a possible rewiring of the financial system and global economy. Is this part of a bigger shift to de-dollarisation and a change in the role of the dollar in the global financial system?” asks Richard Tomlinson, chief investment officer of the UK’s LPPI.
If trends that are already visible continue, such as the US becoming more isolationist, or uptake in the digital RMB in cross-border settlements, or the use of other digital currencies, it could lead to a devaluation of the dollar and threaten its role as the world’s reserve currency. The long-term implications for investors could include more appetite for hard assets or even a reappraisal of the extent to which US government bonds are a haven asset, he suggests.
At Railpen, the £34 billion fund for the members of the UK railways pension schemes, ensuring liquidity on hand and looking for opportunities are key priorities, explains Mads Gosvig, chief officer, fiduciary and investment management.
“We are trying to make sense of what is going on and figure out if there is a bigger plan around, say, depression of the dollar. It’s also conceivable there isn’t a plan. In the short term, we are focusing on how our portfolio is running and ensuring we have enough liquidity so that we can meet payments. In a second step we are watching for any exposure that is particularly struggling in this context, and finally identifying any opportunities which may arise. If we have the liquidity and the risk levels are right, we will consider deploying money into this.”
The Malaysian sovereign wealth fund Khazanah Nasional has traditionally had an Asian emerging market focus, with offices on the ground in China and India among others. However, in the past few years it has been upping its developed market exposure to look more like western allocators and now has around 40 per cent allocated to the US.
“But I think this whole discussion…makes us take a pause,” says Wei-Seng Wong, head of strategy at Khazanah. “Is that the right way to think about it? Probably not anymore. So we really have to relook, not necessarily from a China exposure or US exposure, but really understand, what are the trends? What are the return streams that we want to look at vis-à-vis this bifurcated world.”
While the volatility in stock markets continues to confuse traders, it’s also an opportunity for prudent investors, many of which have abundant liquidity.
CIO of Canada’s OPTrust James Davis says managing risk is critical and has to be the centrepiece of the fund’s investment philosophy. This comes with close portfolio monitoring and the ability to move quickly, which is enabled by the fund’s total portfolio approach and a huge benefit in volatile environments. This flexibility allows it to allocate in an absolute sense and not relative to a benchmark.
“Right now we have an abundance of liquidity,” he says. “That is important given the uncertainty in this current environment.
“This kind of environment in the public markets can create opportunities. Volatility and uncertainty allows for bargain hunting, and more differentiation.”
OPTrust was an early mover into gold, and last year had more than 6 per cent allocated. Davis says it also dialled down credit exposure quite significantly at the end of last year due to tight credit spreads and made geographical weight decisions in the equities market.
“They [the TPA group] have been concerned with the US, especially the concentration risk and exploring opportunities outside of the US,” he says.
Portfolio dynamism
Bernard Wee, group head of markets and investments at the Monetary Authority of Singapore (MAS), says history shows that asset owners have to be mindful of different regimes.
“If you look back at the decades that were horrible, 1970s and the 1940s, they were characterised by a lot of political uncertainty, a lot of conflict, and those are exactly the same forces, the same things that are happening right now,” he told delegates at the Top1000funds.com Fiduciary Investors Symposium in March.
“So if we think that our strategic asset allocations are something that we can just set and forget, that’s something that I would not presume to be true for the coming few years.”
The key, he says, is to be more granular in asset allocation and look for more differentiated characteristics in countries and sectors within asset classes.
Multiple investors, including Canada’s BCI and Singapore’s MAS indicated in conversations with Top1000funds.com that uncertainties from trade wars and deglobalisation are impacting their scenario analysis.
BCI’s base case is a recession, and MAS is doing scenario analysis for stagflation, an environment in which few assets do well.
Meanwhile, Mubadala Investment Company said uncertainties caused by trade wars and political populism mean investors need to change their mindset to recognise that “volatility is the new norm”.
The Abu Dhabi sovereign wealth fund is weatherproofing its portfolio for multiple macroeconomic scenarios.
“Whereas in the past we would look at two scenarios, a base case, [and] a downside case just to have a plan B,” deputy chief strategy and risk officer Marc Antaki said at a Hong Kong conference last month. “We cannot afford that binary view [anymore]. The scenarios are not that obvious, so we look at five, 10 scenarios.”
“We need the portfolio to be able to be resilient under all types of scenarios and be dynamic.”
In this regard, dynamic asset allocation is becoming more important both for portfolio adjustments on the up and downside, and also for the information short-term movements might give about the long-term direction.
Antaki said it also highlighted the rising importance of investor partnerships as a way to share risks and create common value, adding investors need appropriate and perhaps different resources to navigate more complex underwriting, due diligence and regulatory requirements in the investment process.
The most important thing for Mubadala as a long-term investor is “staying risk-on” despite this period of turbulence, Antaki said.
“At the end of the day, you cannot make money, shape the world or participate in transformation by sitting on the sideline. But at the same time, you don’t put all your bets on in one year,” he said.
“So stay consistent, deploy to the cycle, and be dynamic.”
