Policy and politics is one area where it is possible to gain a competitive edge – through proprietary research, exploiting news bias, and utilising social media.
Parallels with the 1990s
There has been an undeniable shift in fixed income markets over recent years. Volatility in politics has been a defining characteristic and markets have been heavily influenced by policymaker decisions ‒ with politics having similar impacts on fixed income markets to what we saw in the mid-1990s. Policy and politics are driving opportunities in macro in a world where alpha, not beta, is required in fixed income. Passive fixed income may have worked well in the past, but now investors risk being left behind as traditional benchmarks struggle to perform in a changing interest rate environment.
Winners and losers
Working out who to listen to – along with how to interpret the implications for markets – is key to capitalising on the abundant opportunities. Politics by its nature has a larger reporter base, hence listening to the wrong voices or ‘fake’ news can be expensive. The ‘human’ nature of political decision-making also does not lend itself well to investment approaches founded on artificial intelligence or quant models.
Investors have continually been on the wrong side of the market over recent years by following ‘conventional wisdoms’ ‒ markets over-estimated the probability of a UK Remain vote in the European Union Referendum; a Clinton victory in the 2016 US presidential election; and the likelihood of a Le Pen win in France (Fig 1). While commentators wrongly forecasted the outcomes, opinion polls proved to be much more accurate (Fig 2) and these are the kinds of market inefficiencies in the pricing of political risk that creates alpha opportunities for active investors.
Fig 1: Market-implied probabilities of vote outcomes
Source: Macrobond as at Q3 2017
Fig 2: Opinion polling spread
Source: Macrobond, Bloomberg as at Q3 2017
The promised land
With populist politics and more fluid voter allegiances rendering traditional news media and research sources less reliable, adapting to the new environment with a modern approach to investing is crucial in order to gain a competitive advantage. It means combining volatility in an opportunity set with the skill and expertise to monetise this volatility. Ultimately, to understand ‘conventional wisdom’ and when ‘conventional wisdom’ is likely to be proven wrong.
A modern approach
The modern approach requires investors to have access to a broad range of sources for political intelligence. These include the need for proprietary research through direct communication and interpretation with key political and policy influencers, exploiting news bias and effectively utilising social media.
Researching policy processes and influencers:
The key focus here is to understand the process of policy decision-making, then identify the key decision makers and influencers. This requires a focus on how decisions are made, the legal and political processes behind them, and how they are communicated. A modern approach uses many tools – social media monitoring, direct dialogue, etc. – to analyse how policy and political decisions evolve.
Understanding and exploiting news bias:
Fake news - 7 February 2017
Source: The Telegraph
Real news - 1 February 2017
When it comes to access to information, the rise of unreliable news sources and ‘fake’ news means that investors have to be smart and selective in what they consume (above and Fig 3).
Fig 3: Market price of Greek bonds
Source: Bloomberg as at 21 July 2017
Utilisation of social media:
Effectively tracking the views of key market participants, political influencers and public opinion through social media has gained importance over recent years and has become a fundamental building block alongside traditional research methods. Social media has become a powerful medium and its appeal for the policymakers has always been as a way to access a vast audience without the distortion of intermediaries; and for the investor, access to unfiltered insight and breaking news (Fig 4).
Fig 4: Utilising social media
Source: Tweetdeck, for illustrative purposes only
Our current thinking:
The current political backdrop:
- Falling median real incomes and rising inequality has created a backdrop for anti-incumbent political parties and leaders to emerge
- Youth in society has felt disenfranchised and is becoming more politically engaged
- Social media allows new political movements and leaders to emerge at much faster pace than historically, and lessens the influence of traditional media
Our current themes:
- A reinvigorated Franco-German axis may push for closer EU integration
- Italian politics will lead to weak government and a lack of reform – but the problems only bite during the next recession
- Brexit is a mess – UK risk premia needs to rise
- The Trump administration remains a wildcard – there is potential for major economic stimulus, or continued gridlock