Date: 10.02.17 Category: Working For Change
In this roundtable, originally published in CFA UK’s magazine Professional Investor (PI), we continue discussing the subject of political risk. To find out more about the matter, please read the paper The Management of Political Risk and the interview Political Risk in Investment Management, we published earlier this year.
PI: It used to be that political risk was very much something that emerging markets managers focused on. Now, has it arguably become an even bigger concern for developed markets? What are the implications of that?
Thomas Schäubli: One of the big differences between emerging markets and developed markets is the role of politics in these countries. In emerging markets, politics usually enjoys a certain primacy, making it very important for market developments. Politics is also increasingly asserting its primacy in developed markets. Or re-asserting, to be more precise. We’ve seen this with the Brexit-vote, but also the mass immigration initiative in Switzerland. In both cases, the public voted in favour of sovereignty, consciously accepting potential economic disadvantages.
We also see this kind of reasoning in nationalistic or protectionist ideas, and in the fact that a number of countries, including EU member states, have become more authoritarian in recent years. In that sense, the role of politics in developed markets is indeed converging on the role of politics in emerging markets. What this means for investors is simple. We think that political risks are an integral part of any comprehensive risk management. We often hear investors say that politics doesn’t matter that much to markets. At the same time, however, our clients regularly bring up topics like Brexit, the US elections, recent developments in Brazil, the rise of populist movements, you name it. Of course politics matters to investors, and increasingly so.
Philip Chandler: Developed markets still respect property rights so at least you’re unlikely to have your assets seized on a political whim! But whereas emerging market risk might be idiosyncratic, developed market risk is becoming increasingly systemic as many countries grapple with similar problems: how to satisfy a disenfranchised population and future debt/pension/healthcare obligations whilst growth remains anaemic? Trouble in one country is a warning for all, thus inter-market correlations rise as investors (rightly) worry.
Wayne Bowers: At Northern Trust Asset Management, we do not and have not differentiated political volatility based on either a developed versus emerging market perspective. The effects of political volatility can be felt through policy action or inaction that may significantly affect growth, inflation, longer term demographics and short term asset market performance and valuation. In recent years, we have utilized various themes to highlight the various implications and potential downstream effects, most recently themed as “populist roulette”.
Eoin Murray: In a world of structurally lower growth and lower expected returns, perception of geopolitical risk and protectionist policy are seen as two of the largest risks to financial market stability. Just looking at the comparative performance of the Italian equity market relative to its French or Spanish equivalents since the start of this year, as market participants have focused on the range of potential outcomes from the upcoming constitutional referendum, we can see relative underperformance of roughly 15%. That same phenomenon is not only restricted to equities, but is also evident in bond markets too where we have seen a significant widening of the spread on the Italian versus Spanish 10 year bond during 2016.
Jason Voss: I am not sure that I believe it is a ‘bigger’ concern for developed markets. This is because the political gridlock in the United States and in the EU really limits change driven by bad politics. The rise of populism appears to increase political volatility. Yet, I think the irony is that it just leads to less activity as diametrically opposed politicians are emboldened to provide equal countermeasure to these movements. However, I do agree that political risk now must be incorporated into investment decision-making, regardless of your regional focus. Why? Because of globalisation and the largely free-flow of capital, economies, markets, and politics is interconnected like never before. Decisions in one region do affect other regions like never before. In a social media connected world, what happens in North Africa affects what happens in the Yukon.
Wayne Bowers is chief executive and chief investment officer of Northern Trust Asset Management in Europe, the Middle East.
Philip Chandler, CFA, is a fund manager in the multi-asset team at Schroders.
Eoin Murray is head of investment at Hermes Investment Management.
Thomas Schäubli is political risk analyst at Wellershoff & Partners.
Jason Voss, CFA, is content director at CFA Institute and author of multiple books.