Flash back to the start of last year and you couldn’t read an investment outlook which didn’t discuss the potential impact of elections on global stockmarkets. ‘The year of the election,’ it was termed, as voters representing around half of the world’s GDP and half of its adult population went to the polls.
Fast forward to 2025, and here we are. Those elections are now yesterday’s news. The real drama starts this year as new governments roll up their sleeves, dust off the policy playbooks, and get to work. And with voters across the world seemingly voting for change, with developed market incumbents either losing their seats or losing voter share, the behaviour of politicians whether you are Keir Starmer, Donald Trump or Japan Prime Minister Shigeru Ishiba are going to be to try and change the status quo.
The net effect of this will be more extreme policies such as the wrath of Executive Orders we have seen from the US administration since Trump’s inauguration. That will create greater levels of uncertainty within markets and likely means extreme performance at either end of the spectrum. These extremes are what we refer to as ‘fat tails’.
In a normal market environment, extreme losses or gains are rare, and most returns sit somewhere in the middle. However, in environments defined by uncertainty, these ‘fat tails’ become more likely, and they require careful preparation. So, what can investors do to navigate them?
The first rule of navigating fat tails is to remain diversified, namely having a lower amount to the asset classes that could potentially be in those fat tails. However, because we don’t yet know what those asset classes will be, spreading risk across makes a lot of sense and remains the cornerstone of defending against the unexpected.
The second rule? Don’t assume all fat tails are bad. History teaches that today’s negative fat tails often evolve into tomorrow’s performers. Volatility creates opportunity, and fat tails aren’t just bad news, extreme price moves can make asset classes artificially cheap. So, throughout 2025 a key theme for investors is to go fishing for opportunities created by these fat tails.
Casting the line: Where are the opportunities?
Are there any asset classes in those fat tails that currently represent value? Two asset classes that are particularly interesting are small-cap and emerging market equities. Small caps are one of the most overlooked segments of the market, and after significantly underperforming their large-cap peers for the past decade, they are now trading at extremely pessimistic valuations.
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However, despite the negative sentiment the fundamentals for the asset class are good, and fund managers which didn’t have capacity 10 years ago, now do. This is an interesting signal, and additionally markets are concentrated, meaning any spill over into small-cap assets would be very attractive. So, for those investors willing to exercise patience, tolerate short-term volatility and additional risk, small caps offer a rare combination of value, growth potential, and the opportunity to capitalise on an eventual shift in market dynamics.
Another asset class trading at valuations that suggests significant upside potential, is emerging market equities. Maybe less so than small caps but emerging markets are at an interesting crossroads, after years of underperformance relative to developed markets, they are trading at near historic lows.
While challenges of course remain – including geopolitical tensions, high US interest rates and a strong dollar – history shows prolonged underperformance often sets the stage for significant rebounds. As global monetary policy eases and geopolitical risks are repriced, emerging market equities could deliver robust returns.
Learning lessons
Staying in the history books – and guided by the saying that ‘while history doesn’t repeat itself, it often rhymes’, it does offer up some valuable lessons on navigating fat tails. While they are rare, we can look back to Trump’s first term in office between 2016-2020, for the follies of trying to predict what policymakers will do and then attempting to predict what will subsequently happen within markets.
For example, when Trump took office in 2016, initial fears of economic turmoil and geopolitical disruption were widespread. However, we didn’t see the breakup of NATO which many people thought would happen, nor did we see an economic collapse in China that many predicted as headlines abound of trade wars between the two economic giants. In fact, it was quite the opposite, over the period Trump was first in power: Chinese equity markets outperformed the US and the rest of the world.
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The lesson? Predictions fail, but diversified portfolios over time should increase the probability of success. On this front, given the policy uncertainty, diversifying your bond portfolios becomes very important. We have seen with the UK gilt market over the recent years that the way the market perceives government policy can impact in individual markets in a significant way, so spreading risk over different bond markets makes sense. Diversification is the anchor that keeps us steady when the fat tails start to wag.
Diversification isn’t a novel concept — it’s the tried-and-true net that many investors have abandoned in the chase for high returns. With the US stockmarket’s concentrated leadership, yesterday’s winners are increasingly becoming riskier as market concentration grows. We saw this first hand recently with the volatility in technology stocks when DeepSeek made waves. In today’s environment, where the pricier, concentrated and overbought areas of the market are more vulnerable to a policy or disruption shock. It is critical to prepare for the unexpected twists and turns of market behaviour.
Much like an angler patiently waiting for that elusive big catch, we need to stay nimble, keep our lines tight, and be ready to seize the opportunities that arise from extreme market moves. The key is not to become overconfident about the market direction with prospective new government policies, and instead actually manage risk. This is because while we can’t predict the precise shape of the market landscape or the fat tail, we can prepare for the many possibilities.
Justin Onuekwusi is chief investment officer at St. James’s Place
