Measuring Risk
Measuring a country’s risk can be a tricky endeavor. From tax laws to political upheaval, investors have to take hundreds, if not thousands, of different factors into consideration. For instance, tangible moves like an interest rate hike can dramatically hurt or help a country’s businesses and the stock market, but even a mere comment from a prominent politician hinting at future plans can have just as large of an impact. A country’s risk can generally be divided into two groups: economic risks and political risks. Economic risks are associated with a country’s financial condition and ability to repay its debts. For instance, a country with a high debt-to-GDP ratio may not be able to raise money as easy to support itself, which puts its domestic economy at risk. Political risks are associated with a country’s politicians and the impact of their decisions on investments. For instance, desperate politicians supporting nationalizations could pose a threat to investors in certain strategic industries. In some cases, economic and political risks can be intertwined. Argentina’s economy under former Peronist regimes is a great example. In that case, populist politicians implemented policies that undermined the economy, such as energy subsidies and spending from foreign reserves.
Analyzing Risk
There are many different ways to analyze a country’s risk. From beta coefficients to sovereign ratings, investors have several different tools at their disposal. International investors should use a combination of these techniques to determine a country’s risk, as well as the risk associated with any individual international investment or security. Methods used to assess country risk are either quantitative or qualitative. Quantitative analysis uses ratios and statistics to determine risks, such as the debt-to-GDP ratio or the beta coefficient of the MSCI index for a given country. International investors can find this information in reports from rating agencies, financial data providers (such as Bloomberg, Refinitiv, Thomson Reuters, Dow Jones, and Morningstar), magazines like the Economist, and through various other respected financial and economic online platforms. Qualitative analysis uses subjective analysis to determine risks, such as breaking political news/opinion or realistic market rumors. International investors can find this information in financial publications like the Economist and the Wall Street Journal, as well as by searching on international news aggregators like Google News. The most common way that investors assess country risk is through sovereign ratings. By taking these quantitative and qualitative factors into account, these agencies issue credit ratings for each country and give investors an easy way to analyze country risk. The three most-watched rating agencies are Standard & Poor’s, Moody’s Investor Services, and Fitch Ratings.
Checklist & Other Tips
International investors can determine country risk using this simple three-step process: However, just because a country is risky doesn’t mean investors should ignore it. Sometimes increased risk equates to higher potential returns. For instance, a country undergoing an economic reform may be riskier now, but its long-term future may be brighter as a result. International investors can still incorporate risk into a diversified portfolio to enhance potential returns. Here are a few tips to keep in mind when considering riskier investments:
Stay diversified: A diversified portfolio can help mitigate the effects of any one security falling sharply. Try and limit any single security from accounting for more than 5% of a portfolio’s value. Hedge your bets: Some strategies, such as writing covered calls or buying index put options, can help hedge against a market downturn. Advanced investors may want to consider these options. Monitor the situation: Always keep an eye on your investments. Things can change rapidly in international markets - particularly risky ones - so make sure you see any dark clouds before the storm hits.
The Bottom Line
International investors should be cognizant of the many different risk factors influencing their investment, including country-specific economic and political risks. By checking sovereign ratings and doing some due diligence, they can ensure their portfolio isn’t overly exposed.
