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What to do with your portfolio when war is raging

26 July 2014

Geopolitics is posing a greater risk to investors’ portfolios than it has done for years, but it also gives investors the opportunity to be contrarian.

By Daniel Lanyon,

Reporter, FE Trustnet

The Middle East is on fire. Conflicts in Iraq, Syria and Gaza are ongoing and escalating. The Ukraine/Russia stand-off has reached acute crisis point following the downing of flight MH17.

While the tragic events are outside the control of investors they can still have a huge bearing on their assets.

Volatility has been lower than expected for a period of such heightened tension on the international stage, although this seems unlikely to last.

Russ Koesterich, BlackRock’s global chief investment strategist, recently warned investors to expect greater volatility sooner rather than later.

“Low volatility suggests investors are complacent and not taking into account the prospect for bad news. Indeed, there is no shortage of potential triggers for more turbulence ahead,” he said.

“Geopolitical risk is clearly rising. If nothing else, last week’s tragedy in Ukraine demonstrated that the unrest in the eastern part of the country is far from over. Meanwhile, we are witnessing the continued fragmentation of Iraq and now a ground war between Israel and Hamas in Gaza.”

The cushion of quantitative easing is all that is stopping the market selling off says Paul Warner, managing director of Minerva fund managers.

“The QE effect is the main thing keeping markets up but that is going to end in October. In the first Gulf war markets sold off heavily before rebounding quickly,” Warner said.

“The time to buy is when markets go down; if I see markets go down 10 per cent I will buy in.”

The famous quote ‘buy when there is blood on the streets’ is a usually attributed to Nathan Mayer Rothschild who apparently used the mantra to swoop on ultra-cheap stocks after the battle of Waterloo.

It is a morbid notion but there are many scenarios where investing in a contrarian manner can pay off.

However, there are also many where situations have only escalated or stalled, leaving portfolios with greater volatility or at a loss.

Here, we look at different ways to protect yourself and even profit from geopolitical tensions.


Save havens


The safest asset will always be cash and several fund managers – partly as result of increased geopolitical risk – have upped their exposure to money markets.

Somerset’s Ed Lam is currently sitting on a 17 per cent weighting, with FE Alpha Managers John Wood and Marcus Brookes taking even larger positions.

Buying gold has also traditionally been seen as the default flight-to-safety asset, often rising in value during tough times.

The asset has been on a mostly downward trend since 2011, but the tensions in the Middle East and Russia have helped it to gains of 7.52 per cent in US dollar terms this year.


Performance of index in 2014

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Source: FE Analytics


Gold was one of the best-performing assets in 2003 during the Iraq invasion, and also made money in the period after 9/11. According to FE data, the price of bullion rose by over 7 per cent in the week after 11 September 2001, with equities going the opposite direction.

Performance of indices in 2001

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Source: FE Analytics


Warner says investors looking to buy gold in times of political tension should do so via an ETF rather than an open-ended fund, which tends to invest predominantly in equities.

“Gold is interesting asset but gold mining stocks tend to be correlated to equity markets and therefore it makes more sense to hold an exchange traded fund of the actual asset if you ‘re looking for to use it as a hedge,” he said.

Government bonds such as gilts also tend to perform strongly during a flight from risk.


Tracker funds

Passive funds allow investors to get quick and cheap access to an investment idea.

If you believe that an area has oversold and believe in the “buy when blood is on the streets” philosophy, going down the tracker route is a good option.

Investec’s Max King says he likes to use tracker funds when playing relatively short-term plays in his portfolio as they are so liquid.

“We use passives in our Multi-Asset Protector funds because they are easy to trade, low cost and very, very liquid,” he said.

“It means if we want to change asset allocation quickly we can leave the other assets undisturbed.”

However, given the volumes of money the average private investor trades, the issue of liquidity is unlikely to be a factor.

Investors tend to panic in times of conflict, only to rebound very quickly when the markets weigh up the fundamentals.

The MSCI Russia index plunged as the Ukraine crisis unfolded at the beginning of year and further after Russia’s annexation of the Crimea. It is still down 12.22 per cent.

However, the index’s initial nose-dive was matched by a similar speed of recovery despite the imposition of sanctions.


Someone buying in when sentiment was at its lowest in March would have made up to 30 per cent in three months.

Performance of index in 2014

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Source: FE Analytics


If the Russian market again takes a turn, there are a number of exchange traded funds that provide exposure to it, including the HSBC MSCI Russia Capped Index, iShares MSCI Russia and Lyxor Russia DowJones.

Since the market bottomed out in March all of these ETFs are up.

The best performer – HSBC MSCI Russia Capped Index – has returned 19.97 per cent.


Stocks


Conflicts and geopolitical tension have the strongest impact on individual stocks.

A good example is airline and insurance stocks which plummeted after 9/11 but went on to make rapid gains.

IAG – parent company of British Airways – was among several airline stocks to take a hit in the first day of trading following the MH17 disaster but quickly recovered and is now up.

Performance of stock and index since 17 July 2014

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Source: FE Analytics


The current climate could also mean an increase in UK government defence spending, which has been declining over the past few years, potentially boosting defence and specialist technology companies.

UK energy stocks could also be a beneficiary of a reduction in demand from Russian gas which currently supplies 10 per cent of all gas consumed in the UK.

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Data provided by FE fundinfo. Care has been taken to ensure that the information is correct, but FE fundinfo neither warrants, represents nor guarantees the contents of information, nor does it accept any responsibility for errors, inaccuracies, omissions or any inconsistencies herein. Past performance does not predict future performance, it should not be the main or sole reason for making an investment decision. The value of investments and any income from them can fall as well as rise.