UBS: Eventually
Geopolitical events such as the UK referendum on EU membership are troublesome for investors. What is the best way to react? Be brave by taking a position beforehand? Be nimble by reacting to market movements after? Or stay calm and just ride the volatility? So much depends on whether investors feel they have any insights, but even more depends on the incentives facing the investment decision-maker.24.06.2016 | 09:03 Uhr
Geopolitical events have always been a challenge for investors, but on occasion many events can overlap or occur close together. This Thursday there is the UK referendum on EU membership, on Sunday there are the Spanish elections, and, not to forget, the upcoming spectre of the US election.
How can an investor deal with these sorts of geopolitical events? They do not fit nicely on any kind of normal statistical distribution of the kind most people learn about and use. The very bifurcated impacts of some events make the usual approaches to valuing asset prices more troublesome. Consider the potential impact of the UK referendum on the British pound. The market expects the currency to rally on a vote to remain in the EU and to sell off sharply on a vote to leave. Taking the probability-weighted average of the two would give you a number somewhere around the middle - but this middle value is exactly the value that we know is most unlikely.
Most investors have already made the single most important decision on how to handle geopolitical events: their asset allocation decision. Is your portfolio heavily weighted towards developed market government bonds? One can surmise that you have decided to take a cautious approach to geopolitical risk. Are you holding a substantial amount of equities or emerging market debt? Then you are placing a bet that the geopolitical risks will not significantly disrupt your portfolio or investment strategy. Since investors rarely shift their investment preferences radically, most will find that their exposure to geopolitical risk is baked in.
But when you consider the complexity in making a choice, you might decide that you are not too bothered: it is all too difficult and there is nothing to be done. This may sound like a cop out, but it is actually a perfectly valid approach. When you start making decisions where you have no insight to give you an edge, you are no longer investing: you are gambling. Sometimes doing nothing is not a bad decision.
Look back at a few geopolitical events. Some of these could be seen in advance (the Scottish referendum in 2014), some as they evolved (the US government shutdown in 2013), and some could not be foreseen at all (9/11 terrorist attack).
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