Thematic investing focus: security in a world of great-power competition

Daire Dunne, Head of Next Generation Thematic, Wellington Management

Thomas Mucha, Geopolitical Strategist, Wellington Management

A variety of secular trends are spurring innovation and disruption in the global economy and creating what we believe are compelling thematic investment opportunities. We take a close look at some of these trends, the breadth of the opportunity sets and the related risks.

Here we look at the opportunities that are emerging from a new focus on security, driven by our belief that we are in an environment of accelerating great-power competition and geopolitical instability. We think this will lead policymakers to place a high priority on three different facets of security: national security, economic security and resource security.

A shifting world order

Today’s geopolitical environment is the most complex and unpredictable it has been in decades. Geopolitical challenges will probably continue for years to come as the Russia/Ukraine and Israel/Hamas wars, US/China great-power tensions, growing climate stresses and other national security issues further impact the global investment, policy and macro backdrops.

We see three key issues dominating the geopolitical backdrop today:

• The structural decline in US/China relations that is now spreading across Europe and the Indo-Pacific, leading to an environment of great-power competition.
• The escalatory potential of the Russia/Ukraine and Israel/Hamas wars or other proxy conflagrations that may stem from them.
• The increasing national security challenges related to climate change.

Elevated geopolitical risk and deglobalisation are the new normal, potentially increasing volatility in global markets while also presenting a long-term positive tailwind to select industries. The result may be disruption and dispersion across regions, countries, sectors and companies, leading to attractive opportunities for active managers.

National security

National governments are preparing for a decades-long geopolitical competition that will span trade, economic policy, global diplomacy and military/defence policy. Great-power competition is already emerging as a US policy framework and will likely continue to be a focus for decades. Other powers, notably Japan, India, South Korea, the European Union, Australia and the UK are also increasingly looking to adjust their strategic stances for a more hostile international environment.

As geopolitical tensions widen, we expect to see spending on defence accelerate (Figure 1), producing a long-term demand tailwind across “legacy defence” and “defence innovation” companies. “Legacy defence” refers to aerospace and defence companies that mostly cater to military and law enforcement sectors. This will be compounded as global security alliances deepen in the coming months and years.

As governments seek to bolster national security, they will invest in emerging technology. Modern defence arsenals increasingly rely on dual-use civilian/military companies for semiconductor technologies, cyber defence and security, as well as cellular and communications infrastructure.

Figure 1

Economic security

A greater focus on national security should lead to more “protection and promotion” of strategic sectors via policy measures, targeted export controls and legislative actions. Strategic sectors that could be a focus for policymakers include semiconductor technologies and artificial intelligence.

It is likely that certain companies will begin to take precedence within specific countries, becoming national champions — enterprises that are afforded a dominant position in a country’s economy thanks to favourable policy. Global supply chains will also be disrupted as governments encourage businesses to “friendshore” with allies rather than rivals.

In the US, the Inflation Reduction and CHIPS and Science Acts serve as examples of legislation intended to support domestic manufacturing and sourcing from US free-trade partners for strategic industries such as clean energy, health care, and the semiconductor supply chain. The EU has responded in kind with similar policies, such as the European CHIPS Act, aiming to help drive resilience in semiconductor technologies.

Resource security

Policymakers view climate change as a core national security issue, which is underappreciated by markets — a “threat multiplier” further complicating the geopolitical backdrop. Climate change is hitting equatorial and tropical regions the hardest, threatening to exacerbate climate migration, food and water scarcity, agricultural disruption, resource wars, political extremism and health issues. Over the long term, climate change in particular poses a significant risk to food supply and security, as it makes weather patterns less predictable, leading to greater variability in crop yields. Resource scarcity is a concern as well, with the loss of arable land due to urbanisation, industrialisation and reduced biodiversity.

A particular area of focus for governments is access to critical minerals — such as nickel, cobalt and aluminium. These minerals are deemed to be of importance to a range of industries, especially those involved in the transition to clean energy, and inventories are low. The US, China and Russia are already competing for access to these minerals across Latin America, Africa and around the world, and this competition will only accelerate.

Risks and opportunities

These coming disruptions offer significant, long-term opportunities to find winners at the regional, country, industry and company levels; however, there are of course risks to our outlook. Not least is the risk of a major conflict, which is likely to have unpredictable implications on all capital markets. These “fat tails” mean that the ideal path is likely to be one in which security enhancements are made as we concurrently achieve an easing in global tensions. On the other hand, the seemingly inexorable path of climate change and its impact on national security — without significant intergovernmental cooperation — is likely to continue to create opportunities for companies aligned with this theme.

We believe that with proper management, this structural trend could be a long-term tailwind to select industries and companies, which have the potential to benefit from increased spending, policymaker support and national champion status.