Morten Kongshaug, Portfolio manager
• Location: Copenhagen
• Assets: DKK150.8bn (€20.3bn)
• Pension fund for the heavy industry and food production sector
The two recent major political events, Brexit and the US presidential election, have taught us that investors sometimes see increased political risk as a buying opportunity for risk assets. The lesson is that we really have to see a tail risk playing out before we take investment policy into real consideration. Having said that, we are puzzled about the complacency towards some of the possible tail-risk events for the next two years. A trade war between the US and the rest of the world, for instance, has the potential to hurt global earnings in a way that has not been seen since 2008. Yet we are seeing record lows in volatility indices, such as the VIX, and in the volatility of global risk assets. We do not believe the current level of volatility is sustainable. Therefore, we are actively buying volatility in various ways, buying protection against tail risk.
Another tail risk is the situation in Europe, which is very complicated, particularly with regard to France. One the one hand, the most likely scenario is that the outcome of the French election will not lead to a euro crisis. On the other hand, the probability of Marine Le Pen winning is rising. As a result, many investors are implementing short-term protection trades. We have not done that yet, but we are looking into different ways to protect ourselves.
The correct strategy to deal with all these risks may be to wait and see what happens, and not do very much before we actually know the facts. This might be the reason we see such low volatility; most investors may be waiting to see what happens. I feel that we are getting closer to key events that can do a lot of harm to returns for 2017, but right now we are in no position to know what the outcome of those events will be.
Meanwhile, corporate earnings are growing and therefore investors are buying equities. There is still a lot of liquidity in the market, thanks to central bank action. Other than tail-risk events, I do not see many elements that will spoil the party. But globalisation has peaked, as far as we can see, so the consequence of a politically driven trade war would be very bad. Yet we feel that the most likely event for 2017 is a euro crisis. Markets seem to think the likelihood is low, but they have been wrong before.
Christoph Ryter, CEO
• Location: Zurich
• Assets: CHF22.2bn (€20.7bn)
• Members: 82,000
• Defined benefit (DB) pension scheme for employees of the Migros group
We discuss what happens in the world in general, but forecasting the short-term impact on asset classes is very difficult. Before the vote in the UK about Brexit, we decided against shifting the portfolio in anticipation of possible market movements. We did not make a bet on either a yes or no vote, because we did not have sufficient information and we weren’t clear about the effect, positive or negative, that the vote might have had on the market.
The same thing would be true about the US presidential election. We were, of course, closely following the events, but the impact on investment decisions was not significant. In any case, had we known the result, we were not sure about the impact on our investments. Only if we were convinced that an event would benefit the portfolio, would we allocate the resources for researching how to shift the portfolio. But, in the end, we cannot predict what is going to happen. Especially with the election of Donald Trump, one would have expected a much bigger impact on the capital markets than we have seen. It is too difficult to foresee short-term movements in capital markets after such events. So making the right choices in the short term is about good or bad luck.
I would be more positive on the possibility of foreseeing long-term shifts in markets. We believe it is easier to predict the long-term impact of political developments on the capital markets. We may therefore reallocate our portfolio in relation to our long-term expectations of asset price movements.
In the way we discuss political risks, we begin from the ALM [asset liability management] studies, which are normally carried out every three to five years. We then discuss tactical allocations, on a yearly basis, with the investment committee. Within management, we discuss recent developments on a weekly basis. If we believe that an event will have a long-term impact, we will put that in the agenda of the investment committee. But, normally, short-term events like Brexit or the US election are discussed at management level. Only if we foresee long-term impact we will be bring the discussion to the investment committee, which meets every three months.
Some of the recent developments, including the Brexit process and US policy, will be discussed at the next meeting of the investment committee. But, we will have to see the initial policy impact before we take any action.
Marcel Roberts, CIO
• Location: Zeist, Netherlands
• Assets: €9bn
• Members: 15,000
• Defined benefit (DB) pension scheme for Dutch medical consultants
Based on recent experiences, such as the Brexit vote and the US election, we acknowledge that it is difficult to predict the outcome of a political-risk event. It is also hard to anticipate the market’s reaction to the outcome of these events.
However, we do take political risk seriously. We are currently assessing the implications of a breakup of the euro. Elections in France, the Netherlands and Germany all present a risk for the currency. The Brexit vote and the election of Trump did not help in terms of securing the future of the euro.
The scenarios we are considering, other than France instigating a euro crisis, are Germany and the Netherlands or southern European countries leaving the currency union. It is difficult to protect the portfolio from the outcome of these events. The main issue in terms of a euro breakup is our euro-denominated liabilities and interest-rate hedges. A breakup would present operational issues, which we are currently looking into.
If you look back at 2016, with the Brexit vote and the election of Trump, the outcome was predicted wrongly, as was the market response to the outcome. We did not do a lot in anticipation of those events, and that was a good thing because, otherwise, we might have done the wrong thing. For the future, first we will look at the possible outcomes and what the impact could be, and then we will discuss if we have to take measures to protect us.
Whether markets can shrug off the outcome of negative political events is the important question, and we do not have the answer. In general, I believe political risk has increased over the last 12 months, and we have only seen the short-term impact of the Brexit vote and the US election. We have to wait for the long-term response of the market. But as long-term investors, we are more worried about a euro breakup, which we see as potentially more harmful.
In any event, we have a long-term investment goal and can therefore accept some short-term diversion from our goal. In terms of past examples, we did not expect either the outcome of the Brexit vote, or the market reaction to it. We increased our currency hedging against the pound to a small extent, and it worked out well. But it was a minor impact, as our exposure to the UK is limited. In general terms, diversification will always be helpful in times of stress.
Interviews conducted by Carlo Svaluto Moreolo