Geopolitics is back with a vengeance, when it comes to investing in global markets, according to General David Petraeus, a Partner with KKR and a former Director of the CIA
For many years, institutional investors didn’t pay much attention to the state of geopolitics around the world, because they didn’t really need to.
Yes, it was an area that was intellectually interesting, but regarded as of little consequence to their investment portfolios.
But no longer.
Geopolitics is back with a vengeance, according to General David Petraeus, Partner with KKR and a former Director of the CIA.
“There’s been seismic change. As you all know, 11 years ago, you could describe the world as one of benign globalisation. All the barriers to trade, investment, capital flows, even data flows were being reduced,” Petraeus said at the Frontier Advisors Annual Conference in Melbourne last month.
“Now, geopolitics is back with a vengeance. We are in an era, not of benign globalisation, but of renewed, great power rivalries,” he said.
Much of the change has to do with the increasing tensions between China on one side and the US, Europe and Taiwan on the other side.
Geopolitics is back with a vengeance. We are in an era, not of benign globalisation, but of renewed, great power rivalries
On an economic level, the US and Eurozone are concerned about China dumping cheap products onto the global market, undermining the competitiveness of local manufacturers. For example, Petraeus pointed towards the potential of cheap Chinese electrical vehicles flooding the markets.
“China has transitioned faster than any other country to electric vehicles,” Petraeus said. “They have overcapacity in internal combustion engines.
“We’re going to see this across the board in a variety of different sectors and industries, where they are going to have to export their overcapacity.
“Countries on the receiving end of that are not going to like it, because they’re in a fear that their own industries will be put out of business. They’re not going to let that happen. The enthusiasm for the kind of global trade that we had in the past has tempered considerably.”
Situations like these are the reason why the world is currently in an environment of ‘severe competition’, Petraeus said.
“What we have to do is make sure severe competition doesn’t turn into actual confrontation,” he said.
China, Taiwan And The Potential Hellscape
Although there are many geopolitical tensions around the world, including the war in Ukraine, the fighting in Gaza and the existence of ‘digital caliphates’, Petraeus singled out China as his biggest worry.
Asked what a worst case scenario might look like when it comes to China and Petraeus said there was a danger of a relatively minor incident escalating into a full scale war.
“Well, the nightmare is that something significant but not massive, escalates into something that is massive,” he said.
“We’re watching very closely right now what’s going on with the Philippines. China is really harassing the Philippine Navy that’s trying to resupply their ship in the South China Sea.
“They were shouldering the vessel the other day, just ramming and pushing them around. This is thuggish stuff and this can escalate. If you kill some Filipinos, then they have to respond.
“And then you look at the communiqué that the US sent out, and it reminds very pointedly in the final paragraph that the US and Philippines have a mutual defence pact. That means that we have to come to their rescue,” he said.
But Petraeus said he hoped it wouldn’t come that far and said the US was looking to strengthen its deterrent measures instead.
We try to make sure that the elements of deterrence are absolutely rock solid. We're transforming our capabilities in the Indo-Pacific quite dramatically. We are hardening our bases. We're dispersing our forces. We're going underground. We're getting on more, and don't misinterpret this, but on more of a war footing
“We try to make sure that the elements of deterrence are absolutely rock solid. We’re transforming our capabilities in the Indo-Pacific quite dramatically. We are hardening our bases. We’re dispersing our forces. We’re going underground. We’re getting on more, and don’t misinterpret this, but on more of a war footing,” he said.
If China was to invade Taiwan, then the US and its allies would not necessarily embark on a full-blown war against China, but instead would create a ‘hellscape’ in the Taiwan Strait.
“Without getting into the details, just imagine what can be done with unmanned systems underwater, [on the] surface, air, ground, space, outer space, cyberspace, you name it. That’s the intent,” he said.
Recently, the US and Australia unveiled unmanned underwater drones, called the Manta Ray and Ghost Shark, as a form of naval defence.
The use of drones has featured greatly in the war between Ukraine and Russia, with Ukraine taking out some significant Russian warships, despite lacking ships of its own. It is expected that future wars will only see an increased use of drones.
Although the US has a policy of ‘strategic ambiguity’ when it comes to its stance on the independence of Taiwan, clues have been given as to what the US might do when it comes to an actual invasion of the island.
“They need to know that the capabilities we are establishing would make life very, very difficult were they to try to forcefully reunify with Taiwan. And this is why President [Joe] Biden on four occasions has seemingly slipped up and said: ‘Of course, we’ll come to the rescue of Taiwan’,” Petraeus said.
“His national security advisor then rushes out and says that there’s no change to our policy of strategic ambiguity, except that the President has done this not once, twice, or thrice, but four times,” he said.
Petraeus said it had become more and more difficult to invest in the various sectors of the Chinese economy as geopolitical tensions have increased and security concerns take precedence over investment returns.
“Don’t get me wrong. No one wants to see a more mutually beneficial relationship with China than somebody who’s a partner in KKR, the biggest investor of our type in the Indo-Pacific,” he said.
“We still have very large offices in Beijing. We have another one in Hong Kong, a regional office, in fact, one in Shanghai, and so on.
“But we’ve watched as our ability to invest in China has been increasingly constrained. We can’t do anything around ships. But now it’s also biotech, it’s quantum, it’s A.I. (artificial intelligence) and the list goes on.
“It’s anything that touches a surveillance state, which is anything that collects data, which is almost ubiquitous, even in a parking lot company. We actually love parking lots. Roll them up; they print money. They’re almost as good as self-storage units in the United States.
“But what we found is that there are licence plate readers, there’s facial recognition, there’s pattern of life and there’s a live feed in the police station. That’s a cautionary tale,” he said.
Investing in New Countries
Petraeus’ role at KKR includes not only the assessment of geopolitical risk, but also mitigating those risks when it seeks to invest in new countries. The firm constantly asks itself what countries are we not invested in that we should be invested in?
And when it identifies a new country where KKR has a high level of confidence that it can make money in, Petraeus and his team go out to meet all relevant stakeholders in the country, including all the leaders in the country, and then come back and give advice to the co-CEOs of the firm.
“We did this with the Philippines probably about six years ago. No one was investing there because you had this enormous headline risk called President [Rodrigo] Duterte. We didn’t agree with that,” Petraeus said.
“We saw this as a country of over 100 million people, great demographics in contrast to a number of other countries in the Asia-Pacific region, growing middle class, big need for infrastructure, all kinds of other services, and so on.
We determine whether or not we can mitigate the risks of what we've identified. Generally we can, although when we cannot, we veto the deal. I've actually vetoed about seven deals or so over the 11 years that I've been the chairman of the KKR Global Institute and a partner at KKR
“Yes, Duterte was there, but generally, if you didn’t deal drugs, you were probably okay.
“I personally did two of the four trips that we went out there. We met with everyone from all the military leaders, all their economic financial leaders, the business community leaders, the US Embassy, the CIA Station Chief, Duterte, and came back and said: ‘We need to be in the Philippines’.
“Headline risk scared all the people off, but we’ve done at least seven major investments, and we do investments that are big. There’s nothing small if you’re managing $578 billion, and it has been very, very successful. We now have a team on the ground there,” he said.
But Petraeus doesn’t always manage to mitigate all concerns, when assessing a new country to invest in. Sometimes the troubles are of such nature that the firm simply needs to give it a miss.
“We determine whether or not we can mitigate the risks of what we’ve identified. Generally we can, although when we cannot, we veto the deal.
“I’ve actually vetoed about seven deals or so over the 11 years that I’ve been the chairman of the KKR Global Institute and a partner at KKR,” he said.
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