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The Case for Macro

Our Dynamic Allocation Strategies team explains why global macro investing offers many potential benefits when included in an investment portfolio. Read More (PDF)

Emerging Markets Outlook for 2017

The past 12 months have been fairly turbulent in emerging markets, but a number of factors support emerging market performance.  Read More (PDF)

Populist Ground Swell Surges

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We often talk about the ground swell of populism that has taken hold in many parts of the developed world during the last couple of years. And populist movements continue to bubble up, most recently in Italy where voters soundly rejected Italian Prime Minister's Matteo Renzi's referendum on constitutional reform.

In each case, populism has proved more powerful and further reaching than almost anyone predicted along the way.

If we look back in time to January 2015, populism's furthest political advance was in Greece, where Prime Minister Alexis Tsipras and the Syriza party came to power. Fast forward to June 2016 and Brexit was populism's biggest achievement, only to be dethroned in November when Donald Trump won the U.S. presidential election. Several commentators have since described the Trump win as Brexit times 10.

Populism has proved more powerful and further reaching than almost anyone predicted along the way.

This populist surge has continued in December 2016 with the crushing defeat of the Italian referendum by a wider margin than expected. Ironically, the referendum, which included reforms designed to increase governmental stability, was initially popular. But when Prime Minister Renzi associated himself with the reforms by saying that he would resign if the referendum was rejected, he ignited an anti-establishment sentiment that is a hallmark of these populist movements.

As a result, Renzi has offered his resignation, thrusting Italy back into political uncertainty with almost nothing to show for it.

How We Navigate Populism

We, of course, have accounted for populism in our investment analysis along the way through our macro-thematic and geopolitical game theory analysis, and, in-turn, in our portfolio allocations. We believe that we were appropriately positioned regarding Greece, Brexit, the U.S. elections, and now Italy by selectively de-risking heading into these geopolitical events and then appropriately re-risking on or near the back end of the point of inflection.

Most recently, for example, we significantly reduced our Italian equity exposure in the months and weeks leading into the Italian referendum but, in large part due to our game-theoretical analysis, began to re-risk in the days prior to the referendum—in line with our fundamental view—once it became clear that a “no” vote was sufficiently priced into the market.

That doesn't mean we've been entirely insulated; there may be occasional short-term portfolio downside moves around these events. A telltale sign of this uncertainty is when correlations increase and diversification narrows. For instance, emerging market currencies became more correlated to each other following the U.S. presidential election, behaving more like one exposure.

We don't always remove all of the risk so that we avoid these events altogether. We have, however, scaled down the risk exposures so that they are reduced relative to the fundamental opportunity, and we have recently oriented the exposures further away from these macro geopolitical risks than would otherwise be the case.

We also used options on the fixed income, equity, and currency exposures in the portfolio to help navigate many of these geopolitical risks. We do this as part of our downside risk management practices. Essentially, we have maintained lower risk than would otherwise be appropriate for these particular longer-term fundamentally attractive opportunities due to a focus on navigating these recent geopolitical scenarios.

Currency Strategy Shift

As we seek to navigate these populist risks, we have also shifted some of our currency exposures toward those currencies where the populist wave has already crashed. For example, we have increased our exposure to the U.S. dollar, the British pound, and the Philippine peso. The new Philippine President Rodrigo Duterte has been taking an aggressively populist stance and the currency has weakened significantly.

In addition, we have moved currency exposure away from currencies where there has not yet been a populist wave, but where there could be, as well as away from currencies that are more vulnerable to populist policies emanating from elsewhere, such as the South African rand, Indonesian rupiah, and Colombian peso.

What's the rationale for this currency strategy change? It's not really further de-risking the portfolio. Post the Trump victory, the populism theme is now more intense. We believe that means a greater likelihood of swings toward populist leaders, parties, or outcomes elsewhere.

So, while those countries that have already experienced a populist outcome have lost an amount of uncertainty and risk, this risk transfers to other places where populism has not yet manifested itself. Populist movements, for example, could take hold or increase in intensity and influence in France's presidential election next spring, and in Germany's federal election several months from now.

We believe populism will continue to be a major macro theme and source of risk going forward for most or all of this year, and it will continue to be a primary focus in our analysis and in our portfolio considerations.