Strategies for Hedging Geopolitical Risk

Regardless of your social or political leaning, there’s no denying that the global geopolitical landscape is evolving at a rapid pace. These increasingly complex, cross-border dynamics have impacted businesses globally, affecting the PE world by extension. Investors in the private capital markets can set themselves apart by pursuing strategies and methodologies that are specifically tailored to relevant geopolitics and by explicitly addressing the factors contributing to our changing world. 

Major Forces of Disruption

The geopolitical landscape is shifting in a number of complex ways, but the primary categories instigating disruption are regionalism, technological advancements, sustainability concerns, and demographics.

The world is more interconnected than ever before, especially since COVID-19 accelerated the development and adoption of virtual communication and remote collaboration. At the same time, populism and nationalism are creating a drag on globalization trends that have been building for years. With these factors pulling in opposite directions, there’s been a shift toward regionalism, in which many national economies are looking either inward or to neighbors that share tighter cultural and demographic bonds. Indeed, recent major trade agreements have been increasingly bilateral, as policymakers move to deal with tighter circles. It’s more logistically feasible than ever to run an international business, but decision-makers can no longer assume that globalism will continue accelerating. 

Technology is an ongoing disruptive force in all geographies and industries, but the nature of transformation is being shaped by the aforementioned regionalization. Large tech leaders are consolidating influence in regional blocs, where software, hardware, AI, and data analytics companies are able to establish large market share within their geographical sphere. Economic regulations and IP protection have an important bearing on which regional tech leaders will become more embedded in the operations of all businesses moving forward. 

Demographics are also set to play a major role in global business trends. Developed regions frequently have older populations, and these economies are experiencing decelerating growth alongside fiscal drags. Meanwhile, many emerging economies have young populations, which is going to fuel economic activity as those families and middle classes grow. Catalysts are realigning for the upcoming decades.

Finally, environmental regulation and ethics will continue to play an important role in business decisions. ESG considerations are nothing new, but a wealthier and more informed population of investors and owners are opting increasingly for sustainable and humane practices that PE firms should consider when crafting strategy.

Building a Winning Geostrategy

Leading PE firms approach geostrategy in several ways. First, they are challenging the long-standing assumption that emerging markets are inherently riskier than developed ones. Political instability, corruption, and violence were long seen as factors that could inhibit business operations in emerging areas. Those fears haven’t dissipated entirely, but they’ve become less prevalent in many countries, while social strife and trade disputes are becoming more common in developed markets. A more nuanced analysis of today’s geopolitical risks can help bolster returns. 

Firms with the best execution on geostrategy are also identifying opportunities created by the shifting global landscape. They are able to determine which countries, regions, sectors, or industries are likely to benefit from geopolitical changes and allocate capital accordingly. For example, it could be lucrative to own manufacturing interests in whichever countries are the most likely beneficiaries of a trade war between the US and China, should that conflict come to pass. 

Executing the above requires a defined philosophy and approach from fund management. They should have a centralized approach to specific geopolitical topics with an established process. That would dictate how geopolitics are discussed among the investment committee and which sorts of topics need to be addressed during diligence. Firms with enough scale can maintain internal staff specifically to analyze and advise on geostrategic issues, while others may opt for external consultants. PE funds can also provide insights and guidance to portfolio companies, which can create a competitive advantage.

Some funds are already instrumented to focused on these strategic measures, while others still don’t really have the need to dedicate resources to it. Disregard for geostrategy may not doom a firm, but it certainly creates a knowledge gap that is becoming increasingly more relevant. Successful navigation of these issues ultimately requires support from firm leaders, and firm culture needs to reflect the importance of geostrategy in all aspects of management from diligence to investment, growth, and exit planning.