“To some extent, this uncertainty is omnipresent, with the empirical evidence suggesting that it’s rarely game-changing from an economic and markets perspective.
“However, the route for geopolitical events to have a more lasting effect is, in our view, whether they have scope to have a profound and persistent impact on commodity prices or lead to broader market contagion.
“Recent goings-on in Venezuela do not pass muster on either of these fronts – while Venezuela has the world’s largest proven reserves, it’s currently a small producer, and US intervention is likely to increase supply over the longer term. Iran is a different story, with the Strait of Hormuz a significant enough chokepoint to have a profound and persistent impact on oil prices. Meanwhile, escalating tensions over Greenland between the EU and US have scope to cause financial-market contagion if trade disputes spread to the weaponisation of markets.
“However, managing a portfolio for a single upside or downside scenario is often suboptimal. Investors must also weigh the long-term opportunity cost of diversification, striking the right balance between risk-adjusted and absolute returns. Scenario-testing helps identify portfolio vulnerabilities under different conditions and uncover untapped diversification opportunities.
“Echoing economist Harry Markowitz’s maxim that “diversification is the only free lunch” in finance, we recommend scenario-testing portfolios against varied growth and inflation outcomes to uncover vulnerabilities and diversification opportunities.”
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