Quick Thoughts On Geopolitical Risk

Most nation states are fairly rational actors. Iran. North Korea. Even Libya under Qaddafi and Iraq under Saddam. These are not the kinds of regimes I would like to live under. But they are not irrational in their foreign policy agendas, either. Don’t mistake what a head of state says for what that state will actually do. Even the most vile, tyrannical regimes are first and foremost concerned with self-preservation. It isn’t in their interest to start wars they can’t win.

What they are solving for is the optimal mix of shenanigans to maximize geopolitical power and domestic prestige while minimizing existential risk. If you are the kind of person who thinks only OTHER countries operate this way, you have a lot to learn about geopolitics.


Sometimes rationality does not prevail in international relations. Or, for idiosyncratic reasons (see WWI), what appears to be a series of rational actions when taken in isolation ultimately leads to an irrational outcome.

Hence, in my view we tend to overestimate the frequency of severe geopolitical shocks and underestimate the severity of the shocks that will inevitably occur. In other words, we are really, really bad at handicapping expected values related to geopolitical risk.

The obvious lesson?


Now, I enjoy reading foreign policy think-pieces as much as the next guy. Maybe even more than the next guy. (Fun Fact: Many moons ago I took the FSOT. At the time, you took the exam and wrote the essays separately. I passed the exam but promptly failed the essay section. In retrospect, I was almost certainly disqualified for ideological unreliability) Anyway, the way to read a foreign policy think-piece is as a scenario–a scenario that might play out in a grand strategy game like Hearts of Iron. This is essentially a speculative activity (the parallels with investment research should be obvious). The fact of the matter is that this stuff is useful for getting you to think about a range of possible futures and strategic options. It is NOT useful for actually predicting the future.

In practical terms, the way you manage geopolitical risk is with hedges and rules-based guardrails. Personally, I’d rather ignore geopolitical risk all together than make predictions based on subjective probabilities.

This is relatively simple, process-over-outcome and OODA loop stuff. There are dozens, if not hundreds of ways to adapt a portfolio to geopolitical risk without predicting anything. And 99.99% of what’s written about geopolitics is trash, anyway. Per the above, that’s kind of the point.

The challenge here isn’t identifying the right tools, or even understanding the tradeoffs they entail.

The challenge is shot commitment.

12/2019 Permanent Portfolio Rebalance

I deliberately held off on the 12/2019 rebalance for the leveraged permanent portfolio in order to sync the rebalancing checks with calendar month end dates going forward. However, ultimately it was another boring month with the portfolio falling well below its 12% risk target over the one-year lookback period. You can check the one-year trailing data here.

Realized performance for the live strategy since inception is below.

Source: Morningstar; Demonetized Calculations

Despite its brief length this is an interesting time period to examine the live strategy as it demonstrates exactly the performance profile you’d hope to see over longer time periods: limited downside capture with solid upside participation. Since the inception of NTSX in September 2018, this portfolio has actually outperformed the S&P 500 on both an absolute and risk-adjusted basis (you can play with the dates in Portfolio Visualizer if you click the above link). I would not expect that type of outperformance going forward. However, over very long time periods I suspect realized performance will compare favorably with a diversified equity portfolio, due to the strong downside protection.