By Saker Nusseibeh, chief executive officer and head of investment, Hermes Fund Managers
Increased political risk across developed economies means investors must now consider domestic issues alongside traditional economic measures when making investment decisions. The reality for investors today is that politics and economics are so intertwined, neither can be assessed in isolation.
In recent years, investors have tried to incorporate an element of geopolitical risk assessment in emerging markets investments, but it has been at least two generations since they looked at the issue of political risk in the context of developed economies. They need to start. In the history of developed markets, political risk was once the norm, but faded as an investment consideration post- World War II. The period of great stability which followed was in part because the subsequent Cold War provided developed nations a common, external adversary to worry over. With no common ‘enemy’ anymore and mounting internal concerns, the idea we are all friends in the West is dwindling. At present, growing domestic unrest brought on by anger over austerity, worries about resource scarcity and threats of increased taxation has refocused attention on national problems, as opposed to international concerns. This is best exemplified in Europe where structural flaws and varied national interests are leading to increased tensions between EU member countries, similar to those seen in the 19th century.
The seismic shifts occurring in these countries are originating from changes in world power, the disparity of wealth, demographic shifts and the escalation of populism. In this environment, politics can have as much impact on the attractiveness of different markets as GDP figures. Political risk is becoming an increasingly important investment consideration in developed markets and will continue to grow in importance over the coming decade. As more and more nations take a protectionist stance, the investment impact cannot be underestimated. Europe, in particular, is fragmenting as it struggles with structural flaws and varied national interests. Tension between the countries is mounting in much the way it did in the 19th century, and we all know how that played out. The idea of war between developed nations in modern times may seem absurd, yet it is not that far-fetched. We should not forget that for most of modern history these nations have gone to war over economics. Considering today’s growing wealth divide both between countries and within them, it is entirely possible that at some stage some will say ‘enough’ and seek forcible change.
Furthermore, political risk remains an issue in developing economies where change continues to be brought about by the will of the people and economic issues. In these economies, politics and economics are inextricably linked as exemplified by the Arab Spring which was preceded by a rise in food prices. We are now approaching an era when investment decisions cannot be made without factoring political risk into the equation. The way we approach investments has to change. Long-embedded financial concepts, such as mean reversions or efficient market theory, are already lessening in importance. We must wake up to the fact that we do not operate in a hermetically sealed financial system, we now live in a political economy.
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