COMMENTAR Y
Fig.8 Evaluating outside vendors: the most important factors
Internal risk policies and procedures Disaster recovery plans Operational risk insurance Third party audit pricing
Other 0% 3% 20% 40% 60% 80% 100% 91% 77%
40% 38%
Source: BNY Mellon
all had far-reaching and unintended implications to well managed portfolios.
Political risk as the trigger Political risks can also manifest themselves in the form of regulatory changes or improper government oversight of laws. These events are sometimes thought of as one-off events that cannot be measured or predicted and do not rank as highly as market or operational risks in the minds of institutional investors, even though many political events have driven the volatility of markets. In fact, recent studies have shown that the most volatile trading days in US stock markets have been triggered by political events. For those operating in less developed countries, political risk may be predominantly operational in nature.
Referring back to our survey, 8% of respondents are not influenced at all by political risk when making an investment decision, and only 6% are extremely influenced. The focus on political risk has increased somewhat since 2005, where the average response has moved from 2.7 in 2005 to 3.1 (on a scale to 5) in 2013. Interview responses suggested this was because the respondents felt political risk, from an investment perspective, was primarily the investment manager’s responsibility. Only 22% of respondents believe time spent on political risks will increase over the next five years, and 75% believe it will remain the same or decrease, which shows that political risks are not thought to be a growing area of concern. On the other hand, exposure to emerging markets (where political risks are thought to be highest) has increased, with 66% increasing their exposure to emerging market equities and 39.8% increasing exposure to emerging market debt over the last five years.
Measuring political risk Survey respondents largely rely on external resources (50%) and investment advisors (43%) to measure their political risk, with 36.4% stating they do not measure political risk at all. Political events can be difficult to predict and quantify. So with political risks not high on the agenda, but exposures to emerging markets and regulatory changes increasing, do we
50
have the balance right? Many respondents indicated these decisions normally were the responsibility of the investment managers, but do they also have the right controls in place, or are the additional political risks taken by the investment manager offset by the larger alphas they gain? Given the influence politics and political events have had on market returns, credit ratings, regulatory enforcement, reserve requirements, leverage limits, transparency, business practices in areas such as the sub-prime lending market, and the ability of companies to compete on a level playing field, not to mention more serious turmoil that can up-end markets, it appears institutional investors are well advised to pay greater attention to political risks going forward. Institutional investors may want to, for example, spend more time evaluating their investment managers’ and advisors’ understanding of political risks as part of their normal due diligence and selection process and request regular reports from managers and consultants as part of their investment management process. For example, one respondent said: “Political risk is something we let our asset managers worry about and manage.” Another said, “we have a strategic system in place to look at their weights and their views, so that internally they can look at political and social risks, and adjust the portfolio.”
Legal and regulatory risks ranked the highest concerning political risk for survey respondents with 83% of respondents ranking it as important or extremely important, as they did in 2005, with currency inconvertibility and transfer restriction and confiscation, expropriation, nationalisation of the assets or of the company following closely. THFJ
To view the full paper please go to:
http://www.bnymellon.com/foresight/risk/frontiers- of-risk-baker-markowitz.html
bnymellon.com 212.495.1784
“Institutional investors may want to spend more time evaluating their investment managers’ and advisors’ understanding of political risks as part of their normal due diligence and selection process and request regular reports from managers and consultants as part of their investment management process.”
Page 1 |
Page 2 |
Page 3 |
Page 4 |
Page 5 |
Page 6 |
Page 7 |
Page 8 |
Page 9 |
Page 10 |
Page 11 |
Page 12 |
Page 13 |
Page 14 |
Page 15 |
Page 16 |
Page 17 |
Page 18 |
Page 19 |
Page 20 |
Page 21 |
Page 22 |
Page 23 |
Page 24 |
Page 25 |
Page 26 |
Page 27 |
Page 28 |
Page 29 |
Page 30 |
Page 31 |
Page 32 |
Page 33 |
Page 34 |
Page 35 |
Page 36 |
Page 37 |
Page 38 |
Page 39 |
Page 40 |
Page 41 |
Page 42 |
Page 43 |
Page 44 |
Page 45 |
Page 46 |
Page 47 |
Page 48 |
Page 49 |
Page 50 |
Page 51 |
Page 52 |
Page 53 |
Page 54 |
Page 55 |
Page 56 |
Page 57 |
Page 58 |
Page 59 |
Page 60 |
Page 61 |
Page 62 |
Page 63 |
Page 64 |
Page 65 |
Page 66 |
Page 67 |
Page 68 |
Page 69 |
Page 70 |
Page 71 |
Page 72