The Investment Committee in charge of our Gaia portfolios met today to review recent market events.
Recent months have been positive for both equity and bond markets, but the US/Israeli attack on Iran some two weeks ago has changed things meaningfully. Investor focus has shifted from generally positive economic data to geopolitical risk, and the potential for elevated energy process to impact the global economy negatively.
Messaging from the US administration has been inconsistent, with the attack being framed at various times as about preventing Iran obtaining nuclear weapons, degrading their missile and drone capabilities, responding to an “imminent threat” to the US and its allies, and taking advantage of an opportunity to eliminate the leadership. Furthermore, both the US and Israel have been very clear that they would welcome regime change, whilst being careful to avoid saying that it is an explicit goal. Such a lack of clarity on their goals makes it hard to know how long the conflict will last. Whist President Trump suggested four to five weeks initially, since then he has refused to rule out putting US ‘boots on the ground’, which would imply a much longer campaign.
Even if we speculate about what would constitute ‘success’ in the eyes of the US and Israeli administrations, would that be a positive outcome for either investors or the people of Iran? Recent history has shown us that creating a power vacuum by removing a dictator or oppressive regime rarely leads to a period of peace and stability, with Iraq and Libya being obvious examples of the upheaval that can follow. There is little evidence that this lesson has been heeded by the US or Israel, or that there is much of a plan for what happens afterwards.
The committee agreed that, with such a lack of clarity around how this conflict will progress, it was necessary to position for the possibility of both a short and a long war, effectively hedging our risks. To that end, we agreed to make two significant changes.
Firstly, we have moved to an overweight position in equities. The committee had planned to do so before the attack on Iran, but the move we are making is a little larger than we had intended previously, to take advantage of the lower prices in equity markets. By ‘buying the dip’ in this way we have added assets that should perform well if the war is short-lived and energy supplies return to normal.
Secondly, we have looked to protect against the effect of higher energy prices. With 20% of the world’s energy passing through the Straits of Hormuz, a prolonged conflict keeping energy prices high would be damaging for company profits, as well as putting upward pressure on inflation, which in turn is not a great scenario for either equities or bonds. Gaia’s sustainable mandate prevents us from investing in oil and gas majors, companies whose share prices would be the most immediately sensitive to energy prices. Therefore, the committee focused on the effect of higher prices, namely an increase in inflation. As a result, we have added inflation-linked bond exposure to the portfolios, as this asset class is one of the few that would benefit from such a scenario.
Of course, should the war be relatively short, the inflation-linked bond holdings may well fall. However, in that event, we would expect the other parts of the portfolio to do well, especially equities, to which we have added. Therefore, these moves are designed to hedge an outcome on which we can have no clarity.
Having made these changes, the committee will continue to monitor developments and make any further adjustments as they become necessary. Clearly, and most importantly, from a humanitarian point of view, we hope that the conflict ends as quickly as possible.
