Shift away from globalization seen as an advantage for active management

While money management sources are split as to how far the trend of deglobalization has to run, one thing's for sure: It's going to be a good opportunity for active management.

Exacerbated by Russia's invasion of Ukraine, deglobalization is set to slow trade, hit supply chains and create regional blocs. For institutional investors, the challenge is whether their definition of diversification and their approach to investing — particularly if they favor passive allocations — are still relevant.

"Globalization, by most or all of these metrics, seems to have peaked several years ago, and has been either flatlining or declining since," said Jared Gross, New York-based head of institutional portfolio strategy at J.P. Morgan Asset Management, which manages $2.77 trillion in assets.

He said deglobalization has the potential to create regional trading zones, or treaty-based trading partner communities that are smaller, less diverse and potentially higher cost than the full global economy.

"(It is) the idea that you want to base your trading relationships on not just the cheapest partner or potentially even the partner with the highest quality products, but partners who share a kind of mutual sense of self-interest," he said.

Regional trading blocs, as well as economies and companies that can benefit from a more challenging environment, will make a great case for active management, according to Mr. Gross.

Other sources agreed. "More volatility and more uncertainty requires the expertise of those that know what to do," said Luca Paolini, chief strategist at Pictet Asset Management, based out of Geneva, Switzerland. "But we (active managers) need to prove that we can deliver that."

Mr. Paolini added that deglobalization makes passive investing less appealing for institutions' portfolios as more business fragmentation means less correlation among stock prices and more opportunities to outperform benchmarks.

Pictet Asset Management had 213 billion Swiss francs ($223.1 billion) in assets under management as of June 30.

Periods of deglobalization also highlight the importance of being truly diversified. John Delaney, Philadelphia-based portfolio manager at Willis Towers Watson PLC, based in Philadelphia, said that there are two factors that institutions should consider: How will companies seek to manufacture more goods in the U.S. or shore up supply chains, and what is the time horizon and the implications of deglobalization. WTW's advice to clients to help them ride out challenging periods is to ensure that their portfolios are broadly diversified across risk premiums.

Another problem is the inflationary nature of deglobalization, which JPMAM's Mr. Gross warned is also a headwind for central banks already fighting spiraling inflation. He added that deglobalization will, in this way, have a direct effect on the shape of the yield curve and markets more broadly.

However, the inflationary impact of deglobalization will be a medium-term challenge for investors rather than long-lasting, said Cameron Brandt, director of research at institutional fund flow data provider Emerging Portfolio Fund Research Inc. That's because when international trade is interrupted, it takes time for domestic alternatives to replace the cheaper producers and service providers abroad — but many can eventually be replaced, he said.

"Longer term, the case can be made that the inflationary consequences of any deglobalization will be limited," Mr. Brandt said. "Trade will find a new equilibrium, and the ongoing disruptions will accelerate the adoption of productive new technologies."

And although globalization has facilitated lower costs, faster growth and efficiency, these benefits come at the cost of supply chain vulnerability, or overdependency on one nation, said Steven Foresti, chief investment officer of global asset allocation and research at Wilshire Associates Inc., based out of Santa Monica, Calif. The COVID-19 pandemic and Russia's invasion of Ukraine both exacerbated this vulnerability.

But the jury is still out on whether a full-scale deglobalization is happening yet. Sue Crotty, senior vice president and chief investment officer at Segal Marco Advisors, based in New York, explained that the term deglobalization is more of a buzzword than anything.

"None of this happens overnight," she said. "And these things tend to be a long process to get somewhere. That's just the way trends work. Having said that, do we think that there are a bunch of macro factors that are leading to the potential for deglobalization? The answer is yes, just take something like reshoring for supply chain management, and related to either energy security, food security, national security."

Ms. Crotty doesn't see any immediate major implications for institutional portfolios. Rather, many could be bottom-up, or having an effect on corporate profitability and therefore the valuation of companies due to rising inventory costs.

"The important thing for people to consider in their investment programs is thinking about these long-term trends, and how they might impact their portfolios," she said. "And trying to get behind some of the longer-term trends and how those things tend to happen, for example, in private markets, where they're making investments for 10 years out of those sorts of things and being cognizant of these macro trends and watching them is really where we guide our clients at this point."