The Middle East conflict: a portfolio management lens

When I logged on to my Bloomberg terminal the other day, one particular quote caught my eye – “All models are wrong, but some are useful”. It struck me as an apt description of the challenge investment professionals navigate every day when using financial and economic models to assist with portfolio construction. 

At the best of times, future outcomes are difficult – if not impossible – to predict. In this environment, exacerbated by geopolitical forces, conviction in a single forecast feels even less effective than preparation for multiple potential paths ahead. 

That thinking underpins how we approach portfolio construction in the Managed Portfolio Service (MPS) team and wider investment team at Charles Stanley. Rather than positioning for one expected outcome, we consider a range of scenarios that could impact portfolios. The focus is then on building positions designed to withstand or potentially benefit from different market drivers. 

The case for active management  

Asset allocation remains, in our view, the dominant driver of long‑term returns. For investors in actively-managed solutions like ours, asset allocation sits at the core of portfolio outcomes – regardless of whether a portfolio is implemented using passive or active vehicles. 

But what does that mean in practice? 

For me, it starts with accepting the limits of prediction. That means maintaining diversified sources of return and being disciplined around risk while focusing on long-term objectives. Markets are noisy. As portfolio managers, we need to resist the temptation to chase short‑term narratives.  

We also must reflect that the opportunity set for investors isn’t static. As an example, rising volatility and greater dispersion across markets or shares within the same sector could improve the scope for an active fund manager to outperform an index. 

This is where asset allocation and active funds can come together. Asset allocation provides the foundation. Active funds, applied selectively in areas where we feel managers could add the most value, allows us to refine exposures and look for opportunities that passive vehicles may miss.  

In short, active management is about being responsive to the environment. You never have perfect information, and markets don’t follow scripts. The job is to stay disciplined and avoid over‑reacting to headlines. Sometimes that means making changes. Other times, it means having conviction in your positioning.  

How we’re positioning portfolios today 

Since the turn of the calendar year, we have continued to focus on building diversifiers into portfolios. This began with our annual Strategic Asset Allocation review, where we introduced emerging market debt. At the same time, we also looked to introduce positions in commodities and absolute return funds (mandate dependant) to sit along ‘traditional’ asset classes like bonds and equities.  

In the context of the Middle East conflict, areas that have added ballast during equity drawdowns included the US Dollar and infrastructure. We feel the commodities exposure – which goes beyond simply the energy markets – is well poised to perform a similar function for supply shocks, without adding the interest rate sensitivity that can be associated with infrastructure.  

More recently, we’ve made a modest adjustment across multiple portfolios by trimming equity exposure and increasing our allocation to cash. Despite the uncertainty around the Middle East conflict, markets have performed remarkably well. We’re cognisant that the economic and inflationary impacts from this disruption could take time to feed through. We feel they are being underestimated.  

Taking stock of these factors, we felt it was sensible to take a bit of risk off the table in some portfolios. Holding a bit more cash gives us flexibility and leaves us well placed to act if volatility creates better opportunities.  

If all models are wrong but some are useful, the role of portfolio construction isn’t to predict the future perfectly, but to ensure portfolios remain useful across whatever outcomes emerge. 

If all financial models are wrong, then as managers we can try and build useful positions into portfolio to ensure they remain diversified and prepared for different outcomes.