Wargaming a Chinese Invasion of Taiwan for a Hedge Fund's Investment Strategy

Note: This wargame report featured in a Business Insider article, providing a briefer summary.

Context

Wargaming geopolitical scenarios is an exercise familiar to government strategists and military officials. The Knightsbridge Strategic Group’s (KSG) members have experience in wargaming for the highest level of government and military, and continue to provide this. In addition, KSG applies these methods to prepare the private sector for the future, assess possible courses of action, uncover threats, explore opportunities, optimize strategy, and prepare crisis mitigation.

This report provides a brief outline of findings from a simulated wargame for a London based hedge fund (HF) facing a Chinese Invasion of Taiwan scenario. The purpose of the simulated wargame was to provide the HF with:

Insights into threats to its current, and potential future investments, in the event of an invasion.
Strategic development ahead of such a crisis unfolding.

The wargame simulation included several senior decisionmakers at the HF, a KSG wargame facilitator, a KSG junior analyst, and a HF junior analyst. The junior analysts captured the consideration points, strategies, actions and decisions voiced by the HF members when confronted with the China-Taiwan scenario.

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Starting Scenario

Ahead of the wargame, KSG’s leading Indo-Pacific intelligence analyst prepared a starting scenario for the wargame. The scenario was extensive; however, the core points of the starting scenario were:

At 0800 local time, on May 2, 2025, China invaded Taiwan. It first used long range precision strikes and air strikes to soften defences, neutralise Taiwanese offensive capability, and struck key critical national infrastructure. This was accompanied by cyber warfare. In tandem, Chinese navy vessels began moving land forces across the Taiwan Straits.
A series of indicators for the invasion had been visible for circa two months prior to the invasion, however, many analysts in the West dismissed the likelihood of an actual invasion, branding Chinese military preparations in Fujian as ‘posturing exercises’.

At 0930 local time, The US intervened by using long range precision strikes to target the crossing vessels, degraded their progress using cyber warfare, and used its own air defence capability to defend Taiwan.
For out of theatre context, Russia and Ukraine were still locked in a protracted conflict, similar to the line of contact as of Spring 2024.

Publicly released Ukraine battlefield situation by UK Defence Intelligence.

Israel was still conducting operations in Gaza against Hamas similar to its approach as of Spring 2024, although it had hit a period of stagnation in terms of operational progress. European nations were now strongly opposing Israel’s methods, and funding from Europe was being largely cut off, whereas US support was not.

Reacting to the Starting Scenario

With the background established, the wargame began at 1300 local time (0600 in London), and KSG asked the HF to plan its immediate response.

The HF started by liquidating as many of its investments as possible in all adjacent countries to the South China Sea, and rapidly reducing its exposure to investments reliant on South China Sea freedom of navigation. Even in doing this, the HF assessed that most of its portfolio remained indirectly exposed to this event in one way or another, even those based in the continental US, and across the EU. The participants agreed that beyond the effects on corporate revenues from the loss of semiconductors, the global economy would face significant second order effects across a multitude of industries. The HF decided that shifting to gold, US Government bonds, the US Dollar (USD), and investing in South America where exposure was reduced (after a more thorough review) was the likely next course of action. A strong contingency plan for redirecting investment was not fully developed in the real world for a moment like this by the HF. The major short to medium term decision taken was to pull out of high-tech companies given semiconductor chip shortages were likely on the horizon, which would harm the share price of tech giants.

The HF also noted that as news of the crisis broke, the HF would begin receiving floods of calls and emails from investors concerned about their exposure. As such, it was crucial for the HF to placate any worries by having an established response ready to roll out should this event occur.

KSG then asked the HF, ‘what do you wish had been in place before this happened’?

The HF noted that it had already been gradually reducing more direct exposure in the real world to China itself after Nancy Pelosi’s visit to Taiwan in August 2022, and Xi Jinping’s extension to Chinese law permitting him a third term in October 2022. However, the HF had still remained invested in global industry reliant on Chinese labour and markets. Despite the negative effects to investments being seen so early into the invasion, the HF noted that investing in China and the South China Sea was not something that could have been completely vacant from its strategy. The opportunities were too great. In addition, the more indirect exposure was viewed in large part as an inevitable symptom of globalization that it was difficult for the HF to have avoided. The geoeconomic shift to the Indo-Pacific over the past twenty years meant it was unavoidable, and this consequence was always a potential. So, rather than regret having invested in the region, the HF regretted not having an immediate ‘off the shelf strategic shift of investment strategy’ for this scenario that had long been deemed potentially so calamitous. The HF decided it would prepare more detailed response options for such a shift.

The HF noted that supply chains that were contained within the Mediterranean, Atlantic Ocean, and mostly confined to the Americas would have been safer options given the US ability to dominate these spaces and keep navigation open. Considering a distribution of supply chain reliance across the world with more impetus on geopolitical flashpoints would have been a wise consideration with hindsight. This consideration had been included in previous planning, but not at the forefront of concerns.

The HF wished it had bet against the New Taiwan Dollar and Chinese Yaun in greater sums, and had held onto more USD in liquid cash. Going forward, the HF would look at this potential strategy, especially if geopolitical tensions between China-US-Taiwan worsen.

Generally summarising the strategy, the HF would seek to survive the immediate shock and then turn to look at opportunities, such as fishing for newly undervalued hard assets in the Atlantic space. KSG also flagged the potential for filling a void of investment left in Africa by China. The war in the South China Sea would prevent Chinese physical access to Africa for its investments in mining (for example of lithium), and Western companies may be able to capitalize. The HF also assessed that many financial institutions would soon collapse, and assistance from governments was inevitable.

Reacting to a Second Phase

After a 45 minutes strategizing session, and the HF taking its actions, KSG advanced the scenario:

Four ‘wargame hours’ after the starting scenario, at 1700 local time (1000 in London), the US announced that it had eliminated or prevented the majority of Chinese vessels seeking to cross the Straits from succeeding, however, more attempted crossings were expected. The US added that Chinese bombing campaigns in Taiwan were still ongoing, and causing significant damage. Taiwan announced that its air defence was intercepting Chinese drones and missiles, however, the swarming effect was allowing circa 50% to get through, even with US air defence assistance.
In the cross fire, three commercial vessels were damaged (the severity was unknown), and all shipping through the Straits had come to a halt, according to the US State Department.
The EU condemned the attack and asserted it would heavily sanction China (as it had done to Russia), and provide increased humanitarian and military aid to Taiwan.
The US, UK, Japan, South Korea, and Australia announced they would implement a sanction regime on China. These US allies also announced that they had already commenced operations to assist the US defence of Taiwan, although details were sparse.
The major oil exporting nations in the Middle East called for peace in the South China Sea, but were agnostic on who was at fault.
Russia condemned US aggression in the South China Sea and branded the events as an American attack on China.

KSG asked the HF to respond to these global reactions to the invasion:

The HF was surprised by the extensive sanctions package a Western coalition was set to immediately roll out. The geopolitical assessment it had received previously indicated that the interwoven coupling between the EU and China would prohibit ‘Russia-style sanctions’ from being viable. The HF agreed that any room for avoiding a total divestment from China and the South China Sea was now completely lost, and market re-entry was probably many years away. There was disagreement amongst the HF members about keeping some exposure to China in the first phase of the exercise where plausible, however, the comprehensive Western sanctions response took that off the table. Again, a regret was not having a prepared set of response options for redirecting investments in a scenario such as this.

There was also an absence of strategic consideration in the real world on where the opportunities would be in a scenario like this. The HF agreed that it should have a ‘playbook’ of go to actions ready to consider during geopolitical crises. An action was taken away to work further with KSG on narrowing the ‘opportunities question’ through another exercise. At this stage, the HF realised most of its work in this scenario was going to involve legal issues, and understanding what it could and could not do as legislation towards China was expected to frequently change. An action was taken to ensure access to this kind of advice could be secured in a timely fashion in the real world.

Strategizing longer-term

KSG then presented the HF with one final scenario to address:

A month after the invasion, on June 2, 2025, the war had been contained to the South China Sea, East China Sea, Philippines Sea, Yellow Sea, and Sea of Japan.
The US had not struck the Chinese mainland, and China had not hit any land targets of the US or its allies.

China and the US were in talks to first contain, and ideally end the conflict, brokered by Saudi Arabia.
Global trade had hit a crisis. Insurance companies had stopped underwriting trade:
- Coming from, or into China.
- Planning to transit the South China Sea towards Japan, or into the Indian Ocean via the Straits of Malacca.
The US military arranged blockades of goods heading towards China. This included Chinese oil imports from the Middle-East. China was threatening severe action against the US if the blockades continued, but remained ambiguous on this.
The Bank of England, Federal Reserve, and central banks across the globe began a policy of quantitative easing, and the USD rose in value.
The US & UK Governments began directly buying shares in many crucial companies, particularly those affected by semiconductor shortages.
The US also began freezing China’s USD assets, which reduced liquidity in the system. The US also closed the USD payment system to Chinese banks, and closed markets to Chinese imports. The EU and UK intended to do this also but were far slower in rolling out policy change.
Experts assessed that the Chinese economy was set to shrink by ~30% due to the breakdown in imports and exports caused by the war in the next three months. Chinese ports were seeing a 97% reduction in traffic in the first month of the conflict.
After just one-month, gradual inflation was observable in the US, EU and UK. The value of hard assets thus increased, with initial signs of a global recession forming.
Across the globe the fundamental reaction of financial institutions was consistent - a rush to gold investment as a safe haven, alongside US Treasury Bills, and high-quality USD assets. In addition, financial institutions at large began selling off equities across the Indo-Pacific region.
Commodities associated with semiconductor production also began to rise in value as government and private companies rushed to secure supply chains.
The month had seen significant volatility and increased volumes on futures exchanges in derivative transactions. This was characterised by increases in margin calls (size and frequency), more hedging activity, and more demand for collateral to post as margin. In addition, there was an increase in credit derivatives activity, and intraday liquidity was stressed.
Overall, there was deterioration in credit quality globally leading to higher credit spreads.
Governments across the West sought to create trade financing deals and attempts to reroute supply chains away from affected areas. After one-month this was slow and not yielding great success.
Experts in finance assessed that this scenario did not look so dissimilar to the early stages of the 2008 financial crisis, the impact of Covid-19, the First Gulf War, and the Russian invasion of Ukraine.

For this phase, KSG asked the HF to consider an approach to the next few months, rather than the immediate 24 hours:

The HF decided it would invest heavily in alternative semiconductor manufacture in regions not affected so directly by the conflict. It had already invested in this, but this event meant it would be lucrative to increase investment. The KSG facilitator noted that this conflict between China, the US, and Taiwan would potentially begin a covert and sabotage conflict against semiconductor manufacturers worldwide. Controlling the adversaries access to these key components would become a major war goal of all sides. An action was taken away to further explore the risks associated with said investments under these potential attacks on manufacturing.

In the months before the exercise, the HF had planned a series of investments into China (particularly EVs). This now needed complete revision, and would take time. A contingency in place in advance would have been a good use of precious time. The HF, along with the KSG facilitator, believed a long-protracted conflict would now be seen in the South China Sea for years to come. Increased investment in defence companies was deemed an appropriate area of the portfolio to increase. The HF members concurred that this war was going to affect oil prices, especially if the conflict expanded. The HF believed this conflict could profoundly disrupt energy supplies, making it wise to invest in both alternative energy and oil, given the likelihood of continuously rising prices. With liquidity injections by central banks across the globe likely, the HF would also closely monitor central bank actions and capitalize on any favourable market conditions.

Wargame Takeaways for the HF

The main takeaway was that there was ‘not much avoiding this one’, the event was going to hit everything, and for a long period.

Unsurprisingly, the scenario was assessed to cost the HF an enormous amount. It therefore decided it would pay closer attention to this geopolitical flashpoint in the real world, and reassess its indirect exposure.

The HF ordered a global review of indirect exposure of its investments, particularly in manufacturing and supply chains. There was agreement that buying more domestic enterprises (less globalized) had merits if indicators for this flashpoint became more severe in the real world.

The HF considered that increasing its embedded geopolitical expertise was necessary to regularly report on this flashpoint, and many others, that could catch the HF’s investments off guard. The HF assessed that even an extra day’s notice could prevent enormous losses, and present massive opportunities to exploit. The HF saw fewer ‘opportunities to exploit’ than ‘desperate needs for mitigation’ in this scenario. Greater thought for opportunity was needed in advance of this potential scenario, rather than needing to scramble to make decisions, as the HF was forced to do in the exercise. The HF took away the action to create a new crisis response working method internally, as a lot of the time spent in the exercise was actually used to decide areas of responsibility, not talk strategy. This exercise was considered key to detect that in advance.

The HF members concurred that immersing in this wargame allowed them to clearly think through the threats and opportunities to its portfolio, which reading a report on China-Taiwan could not do. The HF asked KSG to run several more exercises throughout the year on the top geopolitical flashpoints around the globe, as well as deep dive further on China-Taiwan. In particular, there was a need to think about this scenario at the six months point and beyond

Further Round Table

Given the findings of the simulated wargame, KSG hosted a follow-up round table discussion which included inputting the expertise of a former economist at the UK Foreign Office, a former economic security specialist at the UK Ministry of Defence, a former investment banker, and a former sanctions specialist at the UK Foreign Office. This round table was designed to further supplement the wargame, look beyond six months after the starting scenario, and fill in research gaps not satisfied during the exercise.

The key findings included:

Although this scenario did not look so dissimilar to the early stages of the 2008 financial crisis, the impact of Covid-19, the First Gulf War, and the Russian invasion of Ukraine, participants agreed that the medium to long term reverberations to the global economy would be far more devastating, meaning looking towards hard assets in the US was the safest strategy long-term, avoiding temptation for low-cost investments in geopolitically risky areas (not least the South China Sea).

For the long-term after this scenario unfolds, significant state intervention in the economy would likely continue. For example, ongoing support for the financial sector in the form of liquidity and credit guarantees, as well as further emergency fiscal measures for the economy as a whole.

There would likely be opportunities for non-aligned powers willing to play both sides, and benefit from cheap Chinese exports. That is if the war does not entirely prevent Chinese exports reaching their destinations, let alone the ability for Chinese manufacturers to gain access to resources while the war rages.

Unsurprisingly, governments across the world will have to increase investment in semiconductor chips. Activities off-shored to South East Asia will likely be brought back to Western countries, Latin America, and potentially India depending on the spread of the conflict.

Chinese activity associated with financing infrastructure in the developing world (the Belt and Road Initiative) is likely to massively recede. This would provide potential opportunities for new players to emerge in the Global South, particularly if loans can be collateralised. A major example of this would be mining in Zimbabwe.

Western manufacturers could stand to benefit from this scenario given Chinese competition would be reduced, if not eliminated in many Western countries (particularly the US & UK). Ultimately, these manufacturers would be more expensive than the now lost access to Chinese manufacturers, which would lead to inflation in costs, as well as prices for consumers.

Sanctions on China were assessed to have a higher effectiveness potential in contrast to those placed on Russia between 2014-present day. Sanctions on Russia have been somewhat ineffective given Moscow can sell raw materials to non-G7 nations at a discount. On the other hand, China relies on selling manufactured goods to the West, and is a net buyer of raw materials. In addition, Beijing has not developed a strong domestic market to buy the goods it manufactures, which would be able to support the sudden Western purchasing void.