Date: 24.02.17 Category: Working For Change
PI: How should investment professionals manage political risk, and the risk of big, unpredictable events?
Jason Voss: First, and foremost, investors should broaden what they read in order to understand geopolitics better. Geopolitics is the convergence of people, power, preferences, geography, and history; and much of this kind of knowledge is ignored by investors traditionally. Yet, far from simply being about risk mitigation, I think an understanding of geopolitics reveals highly predictable opportunities, too. This is because nations’ geopolitical concerns have a pre-determined, destiny-like quality to them. So beyond learning about geopolitics, because most investing is a zero-sum proposition, one classic way of managing political risk is simply to diversify a portfolio by economic and/or political region. Another suggestion is to recognize which industries are more sensitive to politics, such as energy, defense, and increasingly, other natural resources, like water.
Eoin Murray: Political risk should be understood and managed in the same context as all other forms of risk. There is no single lens through which investors should view risk – a grasp of volatility, correlation risk, liquidity risk and event risk at a minimum are required for a full picture. What perhaps differentiates political risk from other forms of risk is that it tends to express itself as a tail event, but not one that fits neatly on standard Gaussian distributions that are still commonplace in financial analysis – the potential outcomes are extreme and more likely than we would generally ascribe.
Wayne Bowers: Currently, “populist roulette” is leaving global markets unsure of what to expect from the political arena. Politicians have seized on the middle class’s growing anger, giving rise to unpredictable populist political movements globally. While not all populist-driven policies would hurt economic growth, for example new fiscal stimulus to counter potential “secular stagnation” would be welcomed, it is the uncertainty surrounding these candidates that pressures the outlook for risk-taking. At this point, we believe that threats to build walls must be taken as seriously as plans for new infrastructure build-out designed to boost demand.
Philip Chandler: It’s all too easy to become transfixed on upcoming events, but we need to focus on what we can control. First, we need to recognise that political risk is rising and price it accordingly. Second, we need to accept that it’s hard to call binary events – the better solution is portfolio construction which identifies and sizes hedges to protect portfolios on the downside, but doesn’t overly drag on performance if risks don’t materialise.
Thomas Schäubli: Just like they manage any other risk they encounter. At Wellershoff & Partners, one of our guiding principles is that it is not our task to predict the future, but to prepare for it. This is why we are very cautious when it comes to predictions. Our investment approach is macro-based, takes a long term perspective and works with robust portfolios. In this framework, we capture political risks just like we capture financial market risks or macroeconomic risks. There is no reason to treat political risks any differently from other risks. But of course, this implies that it makes sense to employ someone who’s literate in the field and not just to ask, say, the equity analyst to also cover politics in his region. Treating political risks like any other risks means employing political risk analysts just like you employ equity analysts. And it means that you need to make sure that these people sit together regularly and have a fruitful exchange of expertise between them.