When Should We Care About Geopolitical Risk?

Between Trump, Brexit, and the coming French elections, there’s been a great deal of focus on geopolitical risks and their possible impacts on markets and investors. So how do we deal with geopolitical risk? We believe the answer lies in taking a close look at Cycle, Value and Sentiment.

The power of Cycle, Value and Sentiment

As our clients know, at Russell Investments, we believe in the power of a consistent and coherent investment process to guide us in our asset allocation decision making. Not only does a good investment process paint an insightful picture of where the risks and opportunities lie, it also helps avoid the most common behavioral finance mistakes. However, even a well-thought-out investment process has its limitations. No process can cover everything that potentially impacts financial markets.

Geopolitical events and their associated risk are technically out of scope for our investment process. But that does not mean they’re out of mind.

When we designed our investment process, we settled on three building blocks: Cycle, Value and Sentiment­­­­­. These building blocks represent what we believe are the three fundamental drivers of investment returns, and are designed to take advantage of potential opportunities. Depending on our investment horizon, we give them different weights to account for their underlying characteristics.

  • Cyclecovers the medium term.
  • Valueis the quintessential long-term driver of investment returns.
  • Sentimentis short-term oriented.

How Cycle, Value and Sentiment address geopolitical risk

We use Cycle, Value, and Sentiment in our analysis of geopolitical events that have already occurred and geopolitical risks that are still on the horizon.

Outside of a major war, an enormous natural disaster or widespread epidemic, we believe it is unlikely a geopolitical event will have a lasting impact on value. Thus, after a geopolitical event, we can use our Value scores to indicate if the resulting move in financial markets has been big enough to be meaningful. We can also use our Value score to indicate the potential impact of a geopolitical risk. In particular, when markets are expensive, geopolitical risk is to be taken seriously as a possible catalyst for a reversal. In that sense, our Value scores act as a risk indicator for the potential impact of a geopolitical event.

In contrast, geopolitical events and risk are basically par for the course for Sentiment. Our Sentiment scores are specifically designed to respond to market volatility and investor behavior. As such, Sentiment will tell us whether the change in financial markets was abrupt enough to push investors into a state of euphoria or fear. However, because Sentiment is attuned to the response to a geopolitical event as opposed to the event’s character, it does not answer the question as to why markets are moving. And as such, it does not give us insight into whether the move is warranted or overdone. For that we need Cycle.

When we are confronted with a geopolitical event that is both meaningful and abrupt per our observations in Value and Sentiment, we quickly zoom in on the question at hand: has our outlook for the Cycle changed?

If the geopolitical event or risk is expected to change the course of the business cycle, then we want to reflect that in our Cycle, Value, and Sentiment scores. And because that change would run contrary to the changes in Value and Sentiment, it will automatically validate the geopolitical event as significant enough to warrant caution. Of course, the opposite also holds. If we don’t believe the geopolitical risk or event is significant enough to change our Cycle score, then we automatically allow Value and Sentiment to determine when to respond to market volatility.

So, what are these three building blocks telling us now?

Looking ahead, we believe we are past the peak of geopolitical risk, despite a busy European election calendar.

Both Brexit and the election of Donald Trump were events with a real impact, but neither changed the course of our global cycle score. That may not be the case if Marine le Pen wins the French presidency. However, we continue to believe that election result is unlikely.

And even if it does occur, we believe our investment process will take it into account.


These views are subject to change at any time based upon market or other conditions and are current as of the date at the top of the page.

Investing involves risk and principal loss is possible.

Past performance does not guarantee future performance.

This material is not an offer, solicitation or recommendation to purchase any security. Nothing contained in this material is intended to constitute legal, tax, securities or investment advice, nor an opinion regarding the appropriateness of any investment, nor a solicitation of any type.

The general information contained in this publication should not be acted upon without obtaining specific legal, tax and investment advice from a licensed professional. The information, analysis and opinions expressed herein are for general information only and are not intended to provide specific advice or recommendations for any individual entity.

Please remember that all investments carry some level of risk. Although steps can be taken to help reduce risk it cannot be completely removed. They do not typically grow at an even rate of return and may experience negative growth. As with any type of portfolio structuring, attempting to reduce risk and increase return could, at certain times, unintentionally reduce returns. They do not typically grow at an even rate of return and may experience negative growth. As with any type of portfolio structuring, attempting to reduce risk and increase return could, at certain times, unintentionally reduce returns.

Non-US markets entail different risks than those typically associated with US markets, including currency fluctuations, political and economic instability, accounting changes, and foreign taxation. Securities may be less liquid and more volatile.

Russell Investments’ ownership is composed of a majority stake held by funds managed by TA Associates with minority stakes held by funds managed by Reverence Capital Partners and Russell Investments’ management.

Frank Russell Company is the owner of the Russell trademarks contained in this material and all trademark rights related to the Russell trademarks, which the members of the Russell Investments group of companies are permitted to use under license from Frank Russell Company. The members of the Russell Investments group of companies are not affiliated in any manner with Frank Russell Company or any entity operating under the “FTSE RUSSELL” brand.

Copyright © Russell Investments 2017. All rights reserved.

This material is proprietary and may not be reproduced, transferred, or distributed in any form without prior written permission from Russell Investments. It is delivered on an “as is” basis without warranty.

UNI - 11010

© Russell Investments

Read more commentaries by Russell Investments