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Portfolio Investing and Political Risk in Emerging Markets

Portfolio Investing and Political Risk in Emerging Markets. Alison Adams, PhD Boston Economic Club June 10 th , 2009. Use Political Risk Rather than Manage it. In a reactive sense, political risk has been seen as something to be avoided or managed

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Portfolio Investing and Political Risk in Emerging Markets

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  1. Portfolio Investing and Political Risk in Emerging Markets Alison Adams, PhD Boston Economic Club June 10th, 2009 Alison Adams Research

  2. Use Political RiskRather than Manage it • In a reactive sense, political risk has been seen as something to be avoided or managed • For dedicated portfolio investors, political risk can be anticipated and exploited for enhanced returns • Getting ahead of planned and unplanned events is the key Alison Adams Research

  3. Structures and Style vs. Expertise • Expertise is particularly useful for FDI, company specific intelligence, and lobbying. • Upside: detailed analysis, sense of proximity to power, networking • Downside: too close to the subject, often biased, and unduly pessimistic, experts have a bunker problem and often do not have a sense of scale • Research shows that experts have a poor record for predictions about subjects they know very well Alison Adams Research

  4. Structures and Style: Foundations for Using Political Risk • Political Structures • Upside: timing and rules, facilitates comparison with peers, facilitates organization and ranking of detailed information • Downside: can be too broad, can encourage over confidence • Political Styles • Upside: preparation for unscheduled events, facilitates comparison, anticipate policy decisions • Downside: can be too broad, encourages over confidence, style can be malleable. Alison Adams Research

  5. Non-tradable Political Risk • Strategic risk: tends to be slow moving and not conducive to an investment strategy. For example, N. Korea, Iran, and Russian expansionism • Terrorism: tends to be opportunistic and impact is local and temporary. For example, bombings in India, Turkey, and Thailand • Extremely important for governments but not necessarily for economic performance Alison Adams Research

  6. Tradable Political Risk • Scheduled events and anticipated volatility • Local and national elections • Summits • Unscheduled events and reactive investing • Protests and popular unrest • Government collapse • Scandal and corruption Alison Adams Research

  7. Political Structures • Parliamentary Systems: • Presidential Parliamentary Systems: • Presidential Systems: Each structure affords different investment opportunities for the portfolio investor in the form of contrarian views and appropriate risk aversion. Alison Adams Research

  8. Parliamentary System • Parliamentary systems are generally: • Low risk and slow to change • Coalition governments disperse ministries according to interest. i.e. the Left gets the Labor Ministry • Take alarmist views with a grain of salt. For example, the recent election in India • I would generally view long positions as secure Alison Adams Research

  9. Presidential Parliamentary Systems • Range from benign to unstable; a case by case reading is necessary • President versus Prime Minister is unstable: Ukraine • President with the Prime Minister is stable: • Turkey-before and after President Gul Alison Adams Research

  10. Presidential Systems • Presidential systems can change direction substantially in a winner take all context • Regime change can be deep in key ministries • Business/government relationships vulnerable • Polling is crucial to determine long: short decisions • Big bets are possible: Brazil and Lula’s first term; AMLO’s loss in Mexico Alison Adams Research

  11. Political Style • Why it matters for policy analysis • In opaque policy situations, political style is a powerful guide to anticipate policy decisions. i.e. Ecuador’s default • Rule of law is not clear but style is clear. i.e. Putin and TNK-BP; Erdogan in Turkey • It matters to the politicians themselves and defines limits of loyalty and discipline. i.e. ANC National Executive Committee in South Africa Alison Adams Research

  12. Debunking Political Assumptions • In Emerging Markets –all political parties believe in state sponsored growth to one degree or another. • At this point, most political parties are reasonably market friendly. (Ignore swing to the left labels) • What matters most is the quality and quantity of technocrats and willingness to establish best practices. AKP in Turkey, PAN in Mexico Alison Adams Research

  13. Anticipating Policy Change • Not an exact science; but there are clear tendencies. • Transparent democratic processes produce more populist policy • Opaque committee processes produce more balanced results • Civil Law tradition courts usually do not make new law [a notable exception is Turkey’s Constitutional Court] • Presidential decrees will be arbitrary and difficult to anticipate. i.e. Argentina and Venezuela • Rent seeking behavior around natural resources is inevitable. Alison Adams Research

  14. Conclusions: • It is possible to use political risk to maximize returns • Political risk is endogenous to emerging markets • Risk must be put in a relative context • Not all risk is tradable • Presentation is available at www.alisonadamsllc.com Alison Adams Research

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