In a now famous moment of intellectual hubris, Francis Fukuyama in 1989 declared the ‘end of history’.
The impending collapse of the Soviet Union, and the clear triumph of the United States economy, left Fukuyama convinced the big political questions had been answered with Western liberal democracy having won the day. Investors, it appeared, no longer had to focus on broad political changes when considering how to allocate their portfolios.
Clearly, he spoke too soon. Donald Trump’s election and the United Kingdom’s vote to exit the European Union no doubt spring to mind when investors consider political risk over the last year. British Prime Minister Theresa May's decision this week to call a snap general election for June 8 – and the imminent, closely-fought French election, which kicks off this weekend – mean there's no sign of the upheaval ending soon.
Meanwhile Asia is certainly not being spared.
Political risk has quickly become essential to both national and regional analysis in Asia Pacific. Southeast Asia risks becoming the location of another Great Game between the world’s most powerful countries and, on a more local level, corporations and governments alike have become embroiled in scandals that have sent spasms throughout asset markets.
Malaysia’s corruption scandal surrounding Prime Minister Najib Razak and state investment fund 1MDB was seen as part of the reason behind the country’s massive capital outflow in 2015. A political crisis surrounding South Korea’s president Park Geun-hye has spiraled, costing Park her job and sparking corporate governance concerns over some of the country’s biggest conglomerates. Koreans choose a new leader on May 9 – against a backdrop of increased sabre-rattling between the Trump administration and nuclear-armed North Korea.
“In the last few months we have had a number of political-related incidents in Asia as well as Western countries and unconventional leaders being elected,” June Lui, a portfolio manager at BMO Global Asset Management, told FinanceAsia.
That is forcing fund managers in Asia to pay much more attention to politics. They had risked resting on their laurels over the last few years, which Lui admits were generally uneventful. Now, they are anything but.
Changing political landscape
“Since the global financial crisis, there have been substantial changes in many economies, putting back the political debate in the forefront of what should be discussed when making investment decisions,” said Thomas Poullaouec, Asia-Pacific head of strategy and research at State Street Global Advisors.
One key concern among asset managers is rapidly-changing geopolitics in recent years. China’s attempt to expand its influence is a primary factor, but uncertainties have been heightened by recent leadership changes.
Taiwan’s President Tsai Eng-wen and her Democratic Progressive Party have reversed the island’s recent pro-China stance. Rodrigo Duterte, the outspoken Philippine president, has threatened to upend a long alliance with the US, bringing his country closer to China.
“Political risk is always a key feature when we consider investing in Asia,” said Lui. “The bigger uncertainty for us is the potential change in relationship dynamics among Asian countries due to President Trump’s new international strategy, especially his stance on the ‘One China’ policy, the new US-Russia relationship, and the South China Sea strategy.”
China is playing an inevitable role in shaping Asia’s geopolitical landscape. That has become more prominent following Beijing’s desire to turn the country into a global superpower, both economically and politically.
The much-discussed ‘One Belt, One Road’ (OBOR) policy is China’s biggest effort to exert political influence on neighbours. Although it allows China to export excess industrial capacity as domestic growth slows, the initiative is widely seen as politically-driven, allowing Beijing to massively expand its influence.
“It is not really possible to separate OBOR from politics,” Rick Mattila, international head of market strategy at MUFG Securities, told FinanceAsia. “The financial returns of such investments are most likely not a priority in any immediate sense for the Chinese authorities.”
OBOR has already started to shake up the investment landscape. One main beneficiary is Pakistan, which has seen capital inflows bolster its stock market, tripling its value in four years.
China has also created merger opportunities for Pakistani companies. Last year, Shanghai Electric Power acquired a majority stake in Pakistani power supplier K-Electric, while three Chinese bourses will buy 40% of the Pakistan Stock Exchange .
“In the coming years there will be a lot of infrastructure development under the China Pakistan Economic Corridor (CPEC) programme,” said Ali Naqvi, Credit Suisse’s head of global markets for Asia-Pacific.
Grey Swans
Lorne Johnson, a senior portfolio manager with State Street Global Advisors, described political risks as grey swans, adapting the ‘black swan’ terminology coined by Nassim Taleb to describe entirely unexpected events.
“We call them grey swans because they may be unlikely, but they are not exceptionally rare or unknown,” said Johnson. “Thinking about [political development] scenarios helps inform the risk-aware approaches we take across our portfolios.”
This approach appears to be gaining currency region-wide. Asian investors are now mature enough that they are no longer as easily fazed by political developments, said MUFG’s Mattila.
This may be partly because even the most dreaded events can have surprise positive consequences. The most potent example is Donald Trump’s election, which caused paroxysms among the chattering classes but gave markets an undoubted boost.
“Everyone assumed that if Trump won it would be really bad, but the stock market had actually gone up,” said Joshua Crabb, head of Asian equities at Old Mutual Global Investors. “Last year people got Trump wrong, Brexit wrong and the Italian referendum wrong. But even if they got them right, they would have made a wrong decision because they assume that these events would be negative for the market.”
Stock markets have consistently responded positively to seemingly “negative” events. Britain’s benchmark FTSE 100 Index hit a new high in January, while Italy’s FTSE MIB Index rose to its highest level in a year in December, soon after citizens rejected constitutional changes to help economic recovery.
“Some people have realised the importance of looking at how these political developments will change the economy over the long-term, instead of focusing on the short-term impacts on markets," Crabb said. “Taking the US for example, Trump’s tax cut and fiscal stimulus are what made the market rise.”
In the second part of this feature, we ask: Is political risk being overstated?
