The uncertainty created by political and geopolitical events does not diminish the opportunities that may be found by overcoming a domestic market bias and gaining exposure to regions, sectors and companies that can thrive amid disruption.

Kondi Nkosi, South Africa country head for global investment manager Schroders

Current political circumstances and geopolitical events can always provide reasons for investors to think twice about diversifying globally. But is that thinking valid? A closer inspection reveals it may not be.

Even before this year’s political news took shape, investors may have been concerned about the extreme concentration of global equities. The outsized performance of the “Magnificent Seven” (Alphabet, Amazon, Apple, Meta, Microsoft, Nvidia and Tesla) has left the US equity market focused on a small group of mega-cap tech companies, while their performance has also left major global equity indexes – like the MSCI All Country World Index – highly concentrated in the US. All of that can understandably leave some investors feeling convinced they should stay focused on their local markets.

The current political and geopolitical turmoil only provides further reasons to consider maintaining a domestic bias. The daily headlines are filled with ominous news about tariffs. Even though negotiated solutions to the Ukraine-Russia war and the conflict between Israel and Hamas might be possible, the overall global state of geopolitical tension remains heightened.

Do all these factors provide sufficient reasons for investors to avoid or minimise exposure to global equities? In our view, they do not, and in fact there are plenty of reasons to stay globally diversified regardless of how much uncertainty current politics or geopolitical developments create.

1. The impact of tariffs is not uniformly negative across all regions and all sectors

Increased US tariffs affect economies around the globe, and they could lead to a greater weaponisation of trade in the pursuit of political objectives. While both the Trump administration’s policies and other countries’ reactions to them have continuously evolved, the flurry of news may make US investors reluctant to consider expanding global allocations amidst the turmoil of these trade wars.

A key point to remember, though, is that not all countries will be affected similarly. Some regions, and leading companies within them, could benefit from the disruption the trade battles create. As evidence of this, amid the US-China trade conflict that played out during the first Trump administration, a number of “bystander countries” – including Vietnam, Thailand, South Korea and Mexico – were able to increase their exports to the US by offering substitutes or complementary products for those that China had previously been providing. An active global equities portfolio manager, without the requirement to match the country weights of a benchmark index, has the flexibility to both take advantage of the opportunities and mitigate the risks created by the reconfiguration of the global trade landscape.

Further, sectors and companies that have a more domestically focused market will be shielded from much of the tension with international trade. While some large-cap companies serve their own markets primarily, that domestic focus is even more pronounced among small- and mid-cap companies. Again, active managers without any market-cap restrictions have the freedom to consider all those opportunities.

(Our investment and economics teams are providing regular updates on the implications of the tariffs proposed by the second Trump administration. Read some of their recent insights in Who is at risk from tariffs and what do they mean for equity markets? and Trump's on-off tariffs: the potential effects in the US and elsewhere.)

2. Geopolitical events often have only a short-term impact on equity markets

Major events, such as the September 11, 2001 terrorist attacks against the United States or Russia’s invasion of Ukraine, often cause an immediate, major market downturn. But historically, the drop after such events has not lasted long, even for the world’s largest equity market in the United States. (See Figure 1). It does not appear that such events warrant a complete reconsideration of any long-term investment strategies, including global diversification.

Figure 1: The stock market has recovered relatively quickly from past geopolitical events

Based on the performance of the Standard & Poor’s 500 Index

_{Source: “Elections, wars and assassinations: How geopolitical events impact the stock market,” Bankrate.com, 6 November 2024, citing data compiled by LPL Financial. Past performance is not a guide to future performance and may not be repeated.}

3. Historical data shows company fundamentals, not local or global politics, are the long-term drivers of equity returns

The daily political news that can cause short-term volatility in markets does not drive long-term equity returns. Company fundamentals, like earnings, do. Over the past 20 years, the close correlation between the performance of the MSCI All Country World Index and the 12-month forward earnings per share (EPS) estimates for its constituents demonstrates how closely global stock returns track analysts’ projections of corporate earnings growth (See Figure 2.)

While global events can, of course, impact companies’ earnings, all the other factors that can influence a company’s profitability – like its competitive positioning in is industry, the quality of its management team, and the strength of its balance sheet – are all likely to play a far more critical role in how well each company fares amid constantly evolving market conditions.

When portfolio managers say they ignore the events beyond their control that are playing out across the daily headlines and instead focus on the company fundamentals that they can analyse and make decisions about, they are not simply being dismissive. Instead, they are accurately paying attention to the drivers of performance that have proven to matter over the long term.

Figure 2: The earnings projections for global equities are what drive their long-term performance

MSCI All Country World Index (ACWI) versus performance of the MSCI ACWI forward 12-months EPS (earnings per share

_{Source: MacroMicro, based on data from 5 January 2006 to 5 March 2025. Current performance trends are not a guide to future results.}

4. Historically, global equities have fared quite well even amid geopolitical shocks

Amid the market turbulence that alarming geopolitical news can bring, investors may be tempted to stay on the sideline or maintain a domestic market focus. Thirty years of recent history, though, demonstrate that global equities have often done quite well even amid the major geopolitical developments that brought some short-term volatility for global stocks. (See Figure 3.)

Figure 3: Global equities have historically delivered impressive results, despite geopolitical conflicts

Total return of MSCI World Index indexed to 100 ($)

_{Source: Cazenove Capital, LSEG Datastream as at 30 September 2024. Past performance is not a guide to future performance and may not be repeated.}

5. Active managers have the flexibility to mitigate risks and adjust to the long-term global trends that might impact returns at the country, sector and company level

Passive managers have to mirror an index and do not have the freedom to apply any judgement about how long-term trends are impacting markets. Their holdings in each index constituent will be determined by its current market capitalisation, which is influenced by the prevailing collective view of each stock. As a result, passive managers also cannot take a contrary stance when they think the consensus may be wrong.

As noted, but perhaps worth emphasising again, active management allows for the flexibility to increase or decrease exposure to the countries, sectors or individual companies whose fortunes may be impacted differently by the trends influencing markets. It is also critically important to differentiate between the short-term developments that create noise in the markets and the long term-trends that may have a lasting impact.

Conclusion: uncertainty creates both risks and opportunities

Worrisome political environments and geopolitical events certainly foster a temptation to remain cautious until whatever current storms are brewing might pass. But the market volatility that events on the world's political stages can create has not historically persisted over long periods. Some of that short-term market turbulence may even create opportunities that can be taken advantage of by long-term investors.

Other factors, like extreme market concentration and the comparative discounts available on non-US stocks, could have a much greater impact on the long-term outlook for global equities. For investors, any current political or geopolitical conditions do not seem to warrant missing the opportunities that can be realized from portfolios that have the flexibility to seek out the best opportunities in the world, wherever they may reside.

At Schroders, we strive to ensure that the long-term strategies we implement for client portfolios will not be derailed by overreactions to daily headlines. We focus instead on company fundamentals, while considering, when relevant, the trends that are likely to have a lasting impact on countries, sectors, and companies.

Endnote:

_{1. Source: “The ‘bystander effect’ of the US-China trade war,” VOX (EU)/CEPR}

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