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NN IP CIO: Strategies to balance China-US geopolitical risk

The chief investment officer of NN Investment Partners, Valentijn van Nieuwenhuijzen (pictured), talks to Expert Investor about how to hedge US-China geopolitical risks and their possible development if sustainable trends accelerate.

 

Q: Will US-China geopolitical risk intensify more if Trump wins the US election?

Trump’s America first agenda clearly led to an escalation of the strategic competition between the US and China; the trade conflict with China is a good example for it. Despite the eventual phase 1 deal, these fundamental tensions will persist no matter who wins the elections.

Actually, this is one of the few items both candidates agree upon, despite the fact that the presidential candidates clearly differ in their tone and language. Many Democrats supported new tariffs against China; therefore, the views of both parties regarding China cannot be that different.

We expect that both candidates would increase the pressure on China in the coming years.

 

Q: What long-term investment strategies do you think could hedge rapidly rising US-China geopolitical risks?

Rising US-China geopolitical risks can be driven by the following (not exhaustive) unilateral and reciprocal actions:

  • (1) Targeting specific companies that are of strategic importance but derive either a large or growing share of their earnings from the other country’s markets;
  • (2) Rising military tensions in strategically important regions, eg in the Asia Pacific; and
  • (3) Economic sanctions such as trade tariffs, regulatory or market access bans.

A complete and robust hedge against these types of risks is close to impossible to know in advance, but monitoring these risks very closely and balancing both top-down and bottom-up exposure to them in portfolios will be very central in our approach to mitigate potential damage they can create if China-US tensions intensify again.

To build an investment portfolio that is resilient in the face of the above scenarios, we would advocate the following ideas:

In the case of threat (1) and (3): to tilt portfolios towards companies that are principally domestic facing in their respective economies and have robust growth potential and strong leadership positions — even in an economic scenario that is adversely impacted by geopolitical tensions, eg Chinese e-commerce companies and US consumer discretionary and industrial companies which, despite their overseas business, have very limited reliance on the counterpart’s end market.

In the case of threat (2): “safe-haven” assets that still offer some hedging and diversification benefits and are less likely to be collaterally damaged by a “tit-for-tat”escalation, eg gold and long-duration government bonds.

 

Q: Which strategy do you believe could be most successful for European institutional investors if you consider that megatrend themes (ESG, digitalisation etc.) have been accelerated in the pandemic and low interest rates are expected to remain?

Indeed, the pandemic accelerated various long-term trends, including falling interest rates, sustainability and digitalisation. We expect these trends to continue in the coming years, though different conditions are attached to each case.

First, various central banks already gave out guidance that rates are set to stay low in the wake of the slowing recovery; only a surprisingly fast rise in inflation could lead to a regime shift. Therefore, investors have an incentive to reduce their government holding going forward.

Second, investors should search for income streams, which are generated in growth sectors like technology or renewable energy. Risk factors in this sector include new taxes and anti-trust regulation.

Third, sustainability is a clear megatrend for the coming decade. Citizens demand more sustainable policies; policy makers in Europe and elsewhere initiated a wave of new policies which has only started to unfold.

 

Q: Can you envision a scenario where clean energy will remake geopolitics? What effect could this have on US-China geopolitical risks?

The clean energy revolution is set to change the geopolitical landscape in multiple ways, which goes beyond the statement that producers of oil and gas will become the losers of the transition.

  • First, geographical dispersion of renewable energy will most probably lead to global energy markets, which are less oligopolistic than traditional market structures.
  • Second, the energy markets of the future will create winners, which are able to provide critical minerals and specialised knowhow.
  • Third, renewable energy sources will likely give rise to the electrification of energy systems and to continental super grids.

Against this backdrop, the clean energy revolution creates the possibility of a more fragmented world. If containment [policies] by the US and China intensify, then the technology and standard setting for the new energy systems might differ in US-led versus China-led parts of the world.

Elena Johansson

Senior Reporter

Part of the Bonhill Group.