The effect on markets has already been felt with a spike in oil, a rise in the gold price and falls across equity markets.
Since the crisis escalated both brent crude and gold prices have made gains of 5.24 per cent 5.47 per cent, respectively.
Performance of indices since 1 June 2014
Source: FE Analytics
In contrast equity markets are generally down, with the most affected the emerging markets.
Performance of indices since 10 June 2014
Source: FE Analytics
An ongoing conflict could cause a ‘risk-off scenario’ according to Ben Willis, head of research at Whitechurch, with the potential effect on markets could be significant, particularly for equities in emerging markets.
“If the situation escalates and there is some sort of intervention we could expect to see some risk premiums, as risk aversion goes up.”
“When aversion increases investors tend to withdraw from riskier areas of the market such as equities.”
“Asia and emerging markets tend to be seen as being higher volatility markets and so with increased risk aversion you could expect them to see greater capital outflows, and therefore bigger fluctuations in capital value.”
“When you have this level of uncertainty, markets hate it and coupled with the summer where trading volumes tend to lower, it doesn’t take much for volatility to creep in. So, it could be a fragile time but all depends on how things escalate, if they do at all.”
Emerging market equity exposure is held widely across different fund sectors but some of the most heavily exposed in the IMA Global sector include Baillie Gifford Long Term Global Growth which has 74.98 per cent of its portfolio in emerging market equities, Skagen KonTiki which has 61.3 per cent, Neptune Global Special Situations 41.47 per cent, and JPM Global Consumer Trends which has 25.9 per cent.
However, the volatility could provide a buying opportunity for brave investors, Willis says.
“If we see a market correction driven by a macro or geopolitical event it could present a buying opportunity as you want to buy when markets are weak, to give you a good entry point but that doesn’t mean they are not going to fall further first.”
“At the moment they are looking fairly valued and so if you see a correction of 5-10 per cent and you are sitting on cash you should see it as a good entry point to put cash back into emerging markets and Asia.”
Willis says equity markets could also be driven down by higher than average oil prices.
“When the Arab Spring began it had a significant impact on the price of oil. So, the impact on the price we pay for oil will be negative but for the US it will be less so. The US shale phenomena, it is no longer such an issue for America.”
“The key thing is it will be a supply issue. It is currently an unknown but the likelihood is it will be. Therefore we can expect the price to go up, in the short term at least – so we could definitely expect to see more oil price spikes.”
“However, if the oil price goes up you would think the oil majors would stand to benefit as they tend to be price takers rather than price makers. But it might not filter through to profits with short term spikes.”
Richard Marwood, manager of the top-performing £924m AXA Distribution fund says as the crisis unfolds it could continue to hit oil prices, particularly in Asia.
In the IMA universe eight per cent of funds have more than 10 per cent of their portfolios in direct exposure to the oil and gas sector.
In the IMA UK Equity Income sector a total of eight funds including Psigma Income, Insight Income and SWIP Income have at least 15 per cent per cent exposure to the sector.
Julian Jessop, chief global economist at Capital Economics says a protracted conflict in Iraq such – like Syria - would continue to affect markets.
“The situation is highly uncertain at the moment but if you were looking for a potential geopolitical shock to shake the markets out of their current complacency, a huge Middle East rift could be one of them,” he said.
“Markets are particularly vulnerable to these sorts of shocks at the moment because volatility is so low and there is a lot of complacency from investors.”
“Therefore a shock that normally might be shrugged off could have a disproportionate effect. It is definitely, definitely, worth watching.”
“The risk/reward is very real but markets are right to be sanguine about the situation at the moment. However, they could fall a lot further.”
Jessop says the upward movement of the gold price suggests investors are tip-toeing back to gold.
“It hasn’t been a big move yet but it demonstrates gold hasn’t lost its safe haven status. A lot of commentators argued last year after a sharp fall in the gold price that it was no longer a safe haven asset. That misses the point, as last year everything looked rosy. “
“It is certainly reassuring for the case of having a decent allocation to gold in investors’ portfolios.”
The funds with high gold exposure include Investec Cautious Managed which has 9.3 per cent of its portfolio in the metal, JPM Natural Resources which has 14.1 per cent and First State Natural Resources which has 14.9 per cent.
Personal Assets trust, Ruffer and the Trojan fund are three of the defensively minded portfolios to maintain a significant weighting to the metal.
Willis also says the conflict, could provide a boon for investors in gold.
“Gold has definitely been the risk-off trade for the past few years - could continue to go up. Investors will increasingly want something that is tangible, and traditionally it has always been a haven for investors.”
There could even be some positive news for financial markets with improving relations between the US and Iran, Jessop says.
“However, the more unfriendly the US is with Iran the less they are going to be with Saudi Arabia and Israel.”
Several funds have high exposure to Iraq and Saudi Arabia. Franklin Mena has 28.75 per cent of its portfolio exposed to Saudi Arabia, Baring Mena has 14.7 per cent and Templeton Frontier Markets has 14.17 per cent.
