A number of stresses to global financial resilience have come into play that the world has not seen in some time and how they unfold in the near future is still up in the air, the Chartered Financial Analysts (CFA) summit was told. 

Simon Johnson, co-chair of the CFA Institute Systemic Risk Council and professor at the MIT Sloan School of Management, talked about the four main stresses to global financial resilience, including the Russia-Ukraine situation, climate change, crypto assets and surviving a record stimulus unwinding. 

Geopolitical conflict 

Johnson said the geopolitical conflict between Russia and Ukraine has implications for the global financial system that aren’t fully apparent yet. While the world has gone through COVID-19 and supply chain issues, it is also dealing with “a malevolent actor who is deliberately trying to cause instability, drive up gas prices in Europe and feed into inflation.” 

The good news, he said, is that financial reforms in the U.S. and Europe have prepared central banks for unexpected shocks, with COVID-19 acting as a stress test.

“But now we are dealing with something much more complicated – there are price gaps, breakdowns in trust – those are key central issues,” said Johnson. “The trick is that you don’t want officials to suddenly tighten at this stage in the cycle. What you want to do is come into a crisis with the right structure and resilience. You don’t want people to tighten rules or regulations because that can add a potentially destabilizing shock.” 

Climate change 

Then there is the issue of climate change and what kinds of risks need to be considered by financial systems around the world. 

Cryptocurrencies have also put another potential wrench in the system, having been swept up in a sell-off across higher risk assets in early May. Johnson said regulators aren’t where they need to be on this issue, which takes into account market integrity and investor protection.

He said many people in the cryptocurrency market have resisted regulation and perhaps now are learning some of the consequences of not having a certain degree of regulation. The Risk Council warned specifically about allowing Stablecoins to exist in their current form. “This is banking without a licence and banking without a licence typically ends in tears.” 

Investors also need to be ready for a downturn in the economy. “We will find out who is prepared, who has too much leverage and who has high enough equity and there will more than likely be some surprises,” said Johnson. 

Interest rates 

He said it’s difficult for central banks to know how much they should raise interest rates especially with all the various issues going on around the world. 

So, what’s a financial advisor to do and what do they tell their clients?

Jason Hsu, founder and chairman of Rayliant Global Advisors, told the CFAs that the shift from low inflation, low interest rates and the low cost of capital, make for a prime opportunity to find positive rates of return, pointing to emerging markets as a possibility for some investors. 

Hsu said China has been signalling it will be lowering rates and pursuing growth much more aggressively. Many investors may want to diversify into other regions of the world where they’re potentially looking for rate decreases and are pursuing a different policy path because they’re concerned about stagflation in places like the United States.

“Forget the old lessons of tech and all U.S. and start to think about the companies that really can produce value when rates are normalized,” said Hsu. “What then are the economies, other than the U.S., that might potentially be easing?” 

Anne Walsh, CFA, managing partner and Chief Investment Officer Fixed Income at Guggenheim Investments, said the market has changed substantially from 2021 with its compressed spreads and low yields. 

Positive income 

However, long-term investors, pension plans and insurance companies have positive income and the entire market is revaluating on the equity side.

“This concept of actually seeing income for investors is probably the best news,” said Walsh, adding there are asset classes like mortgage-backed securities that may have some appeal now. 

“You don’t necessarily have to go down in credit quality to gain these new income levels that make sense for investors.” 

Albert Trank, CFA, Executive Managing Director and Portfolio Manager at PGIM Private Capital, added that a number of pension plans are looking to diffuse or transfer their liabilities now off balance sheet, a situation low interest rates made it difficult to accomplish.