APPLIED FINANCE CENTREFaculty of Business and Economics

Geopolitics in asset allocationAl Clark, Nikko AMGlobal Head of Multi-Asset

APPLIED FINANCE CENTREFaculty of Business and Economics

Process

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The Changing Face of Developed Markets

Central bank intervention is at historical extremes

Source: Bloomberg, as at Oct 2016

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China India Thailand PhilippinesRussia Turkey Malaysia IndonesiaBrazil Mexico South Africa

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The Changing Face of Emerging Markets

Political capacity to manage macro risk is an increasingly important driver of performance

Source: Bloomberg, 2016

EM Equity Returns in USD

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Macro Risk Increasing in EM

Structural shift in risk favors top-down approach to EM

EM Balanced Portfolio Risk Decomposition

* Rolling risk attribution of Portfolio comprised of 30% EM equities and 35% each to EM local currency and EM hard currency bonds. Source: Bloomberg, 2016

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Equities Local Currency Bonds Hard Currency Bonds FX

Post-2008 Crisis40% Equity Risk

60% Bond/ Currency Risk

Pre-2008 Crisis70% Equity Risk

30% Bond/ Currency Risk

Multi-Asset investment process integrates political risk in to our decision making

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Political Insights

Eurasia Group is a specialist political analysis firm based in NY with 60+ analysts covering over 100 different countries

Nikko Multi-Asset Eurasia Group

Eurasia research

Eurasia Group quantifies political risk to easily compare across countries

Political trajectories are a forward-looking assessment of business impact

Global Political Risk Index (GPRI) Political Trajectories

Incorporating Political Insights

Eurasia Group’s political analysis is embedded in Multi-Asset investment process

A Comprehensive Collaborative 4-Step Process: Multi-Asset Emerging Market Process

Research Portfolio Construction

Risk Management Implementation

Nikko AM makes use of research and analysis provided by Eurasia Group to manage this strategy. Eurasia Group is not responsible for the investment management and operation of this strategy .

ValuationMulti Asset Quant models at the country level

MomentumQuantitative assessment of momentum by asset class

Macro/PoliticalQualitative score on a macro and political analysis, combining Multi Asset and Eurasia research

Adjust Neutral portfolio to reflect asset class hierarchies from research

Stock SelectionQuality screens combined with equity analysts inputs

Downside riskLayered approach to protecting downside

Tier 1− Countries with market

cap above 2%− Min 70% Max 100%

Tier 2− Countries with market

cap below 2%− Min 0% Max 30%

Eurasia ScreenRemove countries with GPRI below 45 and negative trajectory

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Comparing Trajectories

Change in Political Trajectory• Poland leans populist• Hungary tries reforms• Eurasia Group trajectories are adjusted

Supported by other inputs• Earnings momentum confirms trajectory shift

Execution• Sold Poland and bought Hungary

Poland Political Risk downgrade

Hungary Political Risk upgrade

Equity Performance of Hungary over Poland

APPLIED FINANCE CENTREFaculty of Business and Economics

Views

Geopolitical flashpoints increasing due to:• changing US

foreign policy• emergence of

new global leaders

Social instability increasing due to:• uneven

distribution of globalisation

• central banks overstepping their mark

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Increasing Importance of Geopolitics

China:Reform v growth

North Korea:Nuclear tests

Sth China Sea Disputes

India:Modi regime

Japan:Abenomics

Indonesia:Jokowi regime

Russia:Ukraine conflict

UK:Brexit

Turkey:Failed Coup

Syria:ISIS

Iran: Saudi tensions

Saudi:Yemen conflict

South Africa:Zuma v Gordhan

Argentina:Macri backslide

Brazil:Rousseff

Impeachment

US:Trump

Europe:Refugee

crisis

Trump is the manifestation of two deep seated issues:

• Policy settings have created a huge gap in equality

• Globalisation has impacted low wage earners more profoundly

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US

Source: Minack AdvisorsSource:MinackAdvisors

Europe

Europe gripped by the same deep distrust in political institutions as shown by Brexit

BrexitJune 2016

Spanish ElectionJune 2016

Italian ReferendumOctober 2016

French ElectionMay 2017

German Election

September 2017

• Population unexpectedly votes to leave the European Union –Prime Minister resigns

• At the second attempt, still political gridlock as no party (or group of parties ) can form a majority

• Referendum to reduce the powers of the Senate and allow easier passage of structural reform – Renzi will resign if it fails

• Rise of populist, anti-Euro parties amid the security turmoil of last few years

• Merkel’s approval has dived since the refugee crisis, with CDU faring poorly in state elections. AfD continues to rise

What will Europe look like in 12 months?

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Japan

Confidence in Abenomics is starting to wane

Are policy settings the solution or the problem?

Source: Bloomberg

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Eastern Europe

Russia:• Gaining political

capital through handling of Syria

• Pushing for preferred outcome of a ‘frozen ‘ conflict in Ukraine

Turkey:• Erdogan

challenging secular roots with post coup cleanse

• Value to Europe increasing through immigration solution

N - NATO country

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Middle East

Iran:• re-emerging

following the nuclear deal, with sanctions lifted and billions in assets unfrozen

Saudi :• struggling with

US pivot out of Middle East, lost oil revenues and a royal succession

Source: Bloomberg, Tehran Stock Exchange

Saudi Equity Index

Iran Equity Index

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LATAM

Latamcurrency adjustment has been considerable, allowing necessary internal rebalancing to progress

Source: Bloomberg

Latam Currency Index

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ASIA

Asia is experiencing a political ‘renaissance’ with strong, popular leaders enacting meaningful structural reform

Source: SIPRI

USD, bn

ASIA

EU

US

Growth in Military Expenditure

Equity Market Ranking

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Equity Hierarchy

Any references to particular markets are for illustrative purposes only and are as at the date of publication of this material. This is not a recommendation in relation to any markets and no warranty or guarantee is provided.

Asia

Japan

Latam

US

Germany

Europe

EMEA

UK

• Geopolitical risk is increasing in both developed and emerging economies

• Disaffected masses calling for a rewriting of the social contract with their governments

• Embedding a political risk factor in to asset allocation decisions reduces the probability of adverse investment outcomes

• Asia appears the most politically stable in our research• Europe faces the most immediate challenges

Summary

APPLIED FINANCE CENTRE