How important is geopolitics for investors?

Ashleay: Welcome to the “In Your Interest!” podcast. My name is Ashleay and this week I’m joined, as always, by my colleague and Chief Strategist, Sébastien Mc Mahon. This week we have a very interesting meeting with our colleague Dominic Siciliano, Senior Vice-President, Head of Fixed Income. Welcome, Dom.

Dominic: Thank you for having me.

Sébastien: Welcome, Dom. It’s great to have you here.

Dominic: It’s nice to be here. Thanks for having me.

Sébastien: What people don’t know is that Dom is an extraordinary guitar player.

Dominic: But they know it now. If you saw us at the Centraide fundraiser or at the Christmas show. I think we did a good job; I have a great partner in crime.

Sébastien: Yeah. It was a lot of fun. And, you know, I’m learning just by looking at you, playing with both hands and with your eyes closed, and it’s always very inspiring. But where you’re also very inspiring is in fixed income. When people think about investing, everyone thinks about buying stocks—I think Nvidia, Apple, whatever—but the size of the bond market is even larger than the equity market. So what is investing in bonds?

Dominic: Well, nobody ever wants to talk to the bond guy, that’s for sure. But that’s one thing that’s changed recently, I think, because of inflation and how bond prices have changed. But what’s really magical—and I’ll be a bond geek for a couple of seconds when I tell you this—is that there’s everything in the price of a sovereign bond—you have absolutely everything in that price—and it changes instantaneously with all types of information flows (the types of input that we get from economic data, political situations, if we talk about cross currencies, how its interest rate parity with the effects market). The bond market is really an interesting place, where you have almost perfect information in terms of pricing, and it’s always moving every day and you always have new themes. So it’s a lot of fun as an asset class to trade.

Sébastien: Yes. And there’s a bit of everything in that price.

Dominic: Correct.

Sébastien: Including geopolitics.

Dominic: Exactly. With the globalization of the markets (to go through a history lesson)—as you know, we’ve reached a peak, let’s say, in globalization. And that means that, for the fixed-income market, we’ve never been more sensitive to those types of pricing factors.

Sébastien: Yes. And right now, is it busy on the geopolitical side?

Dominic: Super busy. I would say that it’s always been, I think it’s just that now with the ease of access to information and the fact that we know what’s going on around the globe instantaneously… And when I say that, not for the last five years, but if you go back 20 or 30 years ago, you needed carrier pigeons to find out what was happening in China or elsewhere else, now it’s no longer the case.

When you think about geopolitical risk, you can break it down into seven factors:

1. Territorial disputes: so when you look at what’s happening right now with Russia and Ukraine
2. Resource competition: China’s plan to, you know, not seize, I would say, but to control all the rare minerals
3. Security threats: which include nuclear proliferation, for example, with North Korea or what’s happening, again, with Ukraine
4. Alliances and treaties: so, free trade agreements. For example, Canada has a free trade agreement with the US, that’s a geopolitical risk. There’s Brexit, that’s a geopolitical risk
5. Globalization: how we’ve transferred our manufacturing out of Canada and the US, and how now it’s sort of coming back in a de-globalization movement
6. Humanitarian crises: we had the situation in Syria and people exiting Northern Africa to enter Europe, which are, once again, strong geopolitical factors in the marketplace
7. Ideological competition: ideology is where you get right-wing and left-wing if you’re a democratic state; but this also includes different forms of government in terms of dictatorships or communism and how those ideologies compete on the planet.

Sébastien: And these factors are all important because what’s driving the interest rates and bond prices are expectations for future economic growth, expectations for future price growth or inflation.

Dominic: Yes.

Sébastien: Not to mention risk appetite: how much are investors prepared to—well, how much do they want to be compensated for holding long maturity products rather than short maturity products.

So, there’s all these elements here. And of course, geopolitics is at the centre of all these elements.

Dominic: You could pick an argument that Covid was a geopolitical event.

Sébastien: Yes.

Dominic: If you believe that, then it was a strong source of inflation—it was not wage increase or other factors, it’s purely the economy, it’s a geopolitical factor that really moved the inflation dial. So, when I think about it for our investment process, I think that what’s changed is that the geopolitical landscape permeates all aspects of investing right now.

For us it’s very simple: We start with conversations with you, Sébastien, about monetary policy, what we’re we looking for in terms of what the Bank of Canada or what the Federal Reserve is going to do. So that’s the first input that we use and it gives us an idea of what the overnight rate is and what the cheap money or the risk-free rate is for our investment models. And then, from there we’ll look at the fiscal situation and how geopolitical situations can impact the fiscal. If you think about Trump’s tariffs and how that impacted the US economy and obviously inflation and how rate markets move. So fiscal is really important. Regulatory frameworks, too: governments tend to deregulate, escalate regulation or access to markets. And that’s another aspect that has a huge implication for pricing bonds, because the bond market is sometimes a 20- or 30-year obligation, if you like. So you need an idea of those streams. And then you look at relative value in the same asset class to figure out where there’s value. But each of those components is now, you know, really affected by the geopolitical. Consequently, we have to really look at it.

Ashleay: And what are some of those geopolitical themes that are keeping you up at night?

Dominic: Well, I’m a bond manager, so I don’t sleep! Everything worries me. And that’s the job of a bond manager: to always worry about what could happen next. The Deglobalization theme… Obviously, what’s happening in terms of US foreign policy in the Middle East. You can also look at Ukraine-Russia. These have a human component, and it’s very difficult to see those types of things happening.

But in terms of longer scope, we went through a period from the League of Nations, after World War I, to a very strong globalization movement (all the free-trade agreements that were signed, the creation of the Euro area) and now we’re at a peak where, I think, because of the financial crisis of 2008, there’s a move—once again, this is driven by politics—you know, to be more extreme—more left and more right—and that’s creating a shift for deglobalization, which is what we saw in some of President Trump’s policies in terms of barriers to entry, limiting immigration, trying to force a blockade on the external component. Your commercial partner in the international side is no longer your growth engine; you want to bring it back internally. So that process, if it happens, it’s going to have huge repercussions on how we price and how we live, moving forward.

Sébastien: And you know, we just came back from the 2024 iA management meeting this morning, just before we came here. And AI was all over the place in the conversation there. And one point that I was making to a group that I was talking to is that the weaponization of AI, the first layer of weaponization, is not going to be robots with machine guns (like in Terminator), it’s likely going to be disinformation that’s going to be, you know, propaganda through videos. And of course, that bleeds right into the geopolitical risks that we’re seeing. So maybe at some point AI could be used to stir up the geopolitical pot and it could have impacts in markets, in portfolios.

Dominic: Definitely. Misinformation can lead to political decisions. It could lead to people—you know, activism. So it’s something to worry about. It’s definitely a concern for us, moving forward.

Ashleay: And what about geopolitics and ESG? How are they interconnected?

Dominic: That’s a great question, Ashleay. They’re very tied together. When we started really focusing on ESG—let’s say 15 or 20 years ago, when we started talking about that in terms of the process—but it’s really just in the last 10 years, I would say, that it’s taken off in fixed income. All these things kind of make sense. You know, when you look at the environment, it’s a geopolitical risk. If you have—and let’s not talk about climate change, not specifically on that issue, but let’s say you have areas where you have less water. Well, where there’s less water, people have to leave that area. You can’t live in that area or you’re going to have a humanitarian crisis. So the E in ESG is really geopolitical. On the social risk side, if you don’t have fair elections, if you as an investor can’t have your day in court because you have a dictator that’s there or a change in regime, or if there’s no equality for women or minorities are not represented, you need to think about these issues in your investment process. And the same thing with governance. You know, governance is huge in terms of having a stable place where you can communicate with companies to ensure that they’re doing the right thing. Governance is one of those things where—you know, for North Americans it always sounds like “well, of course,” but it’s not the same playing field across the planet. So that’s really important to have an idea on the governance issue. So ESG and the geopolitical are intricately tied together.

Sébastien: And you know, as PMs, we also share some of the same research services like Eurasia groups; there are some sources out there that are very thorough, very even influential, I would say. If people listening to us now are interested in geopolitics, want to follow what’s going on, what would you recommend as a source?

Dominic: It’s a little bit difficult because some of the best sources are paying sources, like we have Eurasia and a couple other services that are excellent that give you a really detailed perspective on the geopolitical position. There are some podcasts you can look at. One of them is the “The World Next Week,” which I listen to once in a while. But there are other ones that are interesting to look at. In terms of books—and this is not a political view—there’s a book that was written by Kissinger called “The New World Order.” It kind of resets your thinking a bit; it’s a good book to get you thinking in a geopolitical way. “The World: A Brief Introduction” is a good layman’s introduction into the geopolitical world. You have to be a fan of game theory, maybe a little bit, very curious. And also, if you’re one of those people that always reads two or three sources—you know, it’s not about being aligned with a political view, it’s about reading the right-wing source, the extreme right-wing source, the left-wing source and the extreme left-wing source, and then you probably get a better picture and you get an idea of what’s happening.

Sébastien: Yes. The Kissinger book has been in my library for two or three years now, and I have yet to read it. So, I think I will follow your lead here and give it a go next week during the spring break here in Quebec City. I just want to add one thing here: You know, we always hear that equity people tend to be more optimistic in personality and that fixed-income people tend to be more pessimistic in personality. You’re breaking the mould! You’re so lucid on all these stakes and curious and interested! So, you’re a good inspiration, I think, for the kids that are thinking of going into investments. Well, fixed income now, it can be very exciting!

Ashleay: I was going to say: you guys have been seeing me grinning all this time. I’m so proud to be working with you guys every day. So, on another note, everyone, thank you for being here. Thank you for listening to us. And Dominic and Sébastien, thank you for answering all those interesting questions. Have a great day everyone!

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