While the short term uncertainties around not only the virus itself but also the assorted governments’ response to it remain the same, the medium term risk profile for markets continues to shift away from potential instability of illiquid markets towards real instability of Geo-politics, in particular the ratcheting up of Cold War rhetoric from the US towards China. It is quite clear to us that the Republican Party tactic of “Don’t blame Trump, blame China” will continue to play out as a deflection policy between now and November and also that the Democrats will try to outdo the Republicans in terms of being ‘tough on China’. As regards being thankful for small mercies, this probably means that the previous ‘bad guys’, Iran and Russia, are now relegated to second tier status as the US can only really have one ‘Red Team’ to oppose their Blue team at any one time. Not that any US politician will dare rapprochement, just that the pressure will ease a little and perhaps even the tensions in the middle east can settle down.

For markets however the moves to potentially weaponise the US financial system as part of the ongoing battle to suppress China as a competitor represent some serious medium term risks. In particular the attempts to prevent US government pension funds investing in China represents the thin end of a dangerous wedge. Given that the financial repression ushered in after the GFC, whereby regulators essentially dictated that pensions and insurers effectively only invest in domestic government securities at ultra low yields, has meant that most fixed income investment is already controlled by government, the shift to control equity investments means that Savings are effectively being nationalised as a tool of domestic and now Foreign policy.

One vector for this that has perhaps not been thought through is that of ESG funds. This has been a huge growth area for the investment management industry in the last few years as almost every sovereign wealth fund, large institutional pension fund and insurance company has signed up to the concept of ESG, however nebulous, and investment managers have welcomed the opportunity to run mandates rather than compete against market cap benchmarks. Look at fund management groups on sites such as FaceBook and linked-in and when they aren’t ‘celebrating’ how diverse they are, they are trumpeting how much they are embracing ESG.

So far it’s been a win/win with relatively little downside or meaningful outside direction, but the reality is that independent fund management has been compromised in favour of what the politicians and the senior management deem suitable for them, rather than the underlying investor/pensioner. The political pressure from the Greens over climate change has been aimed not at investment managers, but at the trustees of pension funds and the senior management of investment management businesses, such that in reality sustainability and ESG has so far largely become about avoiding fossil fuels. Falling oil prices have flattered this as a ‘concept’ whereas in fact its relative performance has been largely a sector bet. But what if the determination of ESG becomes hijacked by an anti China strategy? What if international ESG investors are effectively told by the ‘research’ that China breaches the E, S or G requirements?

The other obvious area is the Chinese ADRs. To date, this has been the easiest way for international investors to play China, but what if the US administration decide that they are ‘not suitable’ for US investors? They could use plausible arguments around free float, accounting and other of the issues to which markets turned a blind eye when the exchanges were chasing flotation fees in the past. All it would take is one tweet to start a run for the exits. China’s response would likely be to switch them to CDRs on the Hong Kong exchange – which would certainly be welcome in the beleaguered SAR. At the same time an obvious return ‘swipe’ would be to revisit the licences for Macau casinos, especially as Sheldon Adelson of Sands China is a major backer of Donald Trump. May you live in interesting times as they say…

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