The Importance Of Assessing Country Risk

The Importance Of Assessing Country Risk
Burma by Julian Cohen. Why?

As UK businesses spread their operations across the world, whether you invest via stockmarket funds or directly abroad, it’s never been more important to assess country risk - and how to do it for your SIPP is shown below

It's Amazing How Many UK Businesses Invest Overseas

Do You Avoid Overseas Investment?

Like many people, you might be aversed to investing abroad.  You might prefer, instead, to invest ‘safely’ in the UK, in businesses quoted on the stockmarket. 

You need to think again!

It’s amazing how much of the income of the UK’s largest companies is generated from around the world.  If they’re trading in an area much less stable than the UK, the effect of country risk on profits of those ‘safe’ UK companies can be considerable.

Whether you choose your own stocks via a SIPP, or whether you’ve selected funds of some description, or more importantly, if you’ve directly invested your money in overseas businesses, you need to properly determine the relevant country risk. 

Two Main Sources Of Country Risk

These are the two areas you need to consider.

1. Political Risk

This is recognised to be a country’s willingness to repay its debts, or to maintain an encouraging climate for foreign investment.

2. Economic Risk

This reflects a country’s ability to repay its debts.  By definition, countries with stronger economies are likely to be more reliable than those with weaker economies.

Both these areas need to be positive.  It goes without saying that a country with a strong economy is unlikely to be a good place to invest if it’s politically unstable.

The Key Indicators To Check To Assess Country Risk

Credit Rating

It’s not just people and businesses that have credit ratings.  Countries have them too.  A county’s credit rating is used to determine its ability to repay its debt. 

Examining country credit ratings is a useful way to identify economies in order of their strength.  The higher the rating, the stronger the economy. 

Many of the large ratings agencies provide figures, including Moody’s and Standard and Poor’s.

Economic And Financial Fundamentals

There are many indicators you can assess, but most analysts tend to examine the following:

  • Gross domestic product
  • Inflation
  • Structure of the country’s financial markets
  • Availability of a range of investment alternatives
  • Historical and current performance of stock and bond markets

Where To Find Information On Country Risk

Excellent sources of information are newspapers such as the Financial Times, the New York Times and The Wall Street Journal. 

More in-depth research on a specific country can be found at the Economist Intelligence Unit and the Central Intelligence Agency World Factbook.  Both of these resources provide an excellent summary of a country’s economic, political, demographic and social climate, in addition to providing country ratings.

There’s obviously a wealth of information online.  But it’s important to ensure it’s independent.  For often the picture can be skewed if there’s an underlying reason for painting a country in a positive light: for example, the presentation by a promoter of a particular investment opportunity.

Three Types Of Markets

There are broadly three types of market:

Developed Markets

This area comprises the largest and most industrialised economies.  The legal and investment systems are well developed and they are politically stable.  They are usually considered to be the safest areas for investment, and as such, the opportunities for investment growth are lower than less mature markets.  Investment analysis usually focuses on economic and market cycles.  Political considerations are less important.  The US, UK and Germany are examples of developed markets.

Emerging Markets

Typified by rapid industrialisation, emerging markets often display high levels of economic growth.  Whilst that’s good for investment returns, it’s accompanied with a higher degree of risk, for there is often more political uncertainty.  In addition to evaluating economic and financial aspects, it’s therefore important to assess a country’s political climate and the possibility of unexpected events.  Brazil, Russia, India and China, often referred to in economics as BRIC, are examples of emerging markets.

Frontier Markets

These are generally smaller markets or countries that impose restrictions on the ability for foreigners to invest.  They are at the higher end of risk and they can often suffer poor liquidity, but the prospect for gains can be significant.  As a rule, they don’t perform in line with other markets.  As a result, they can be useful for investment diversification.  Both economic and political risks need to be assessed very carefully.  Examples of frontier markets are Argentina, Kenya and Romania.

How To Establish The Country Risk Within Your SIPP

If your SIPP is delivering returns exactly in line with your expectation, then you probably don't need to worry too much about country risk.  But if your SIPP is under-performing, or it's over-performing, which could be a warning that you're in for a fall, then follow these steps:

  • Use research tools like those above to establish the spread of markets and countries in which you should be invested, and those you need to avoid, in line with your view of risk.
  • Analyse every one of your holdings to find out in which countries your money is invested.
  • If the proportions are wrong, make the necessary changes.

A report last week cited Germany as the most popular retail market in the world, with 40 percent of global retailers planning to open a store in the country in 2014.  You could benefit from the strength of Germany, as I have done with half the money in my SIPP.

There Are No Short Cuts To Establishing Country Risk

There is no easy way to finding 'the goose that lays the golden eggs'.  Without doubt, the most effective way to establish the countries most likely to produce the greatest returns for the risk you’re willing to take with your money, is thorough research. 

Like everything to do with SIPPs and self-investing, the buck stops with you.  So if you invest in any share, fund, or business with partial or total overseas interests, without doing your homework, you only have yourself to blame if it doesn’t pan out.

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