The New Threat Facing Developed Markets

Political risk analysis, a discipline once reserved primarily for emerging market investors, is now crucial for investors holding securities in the U.S., U.K., Europe, Australia, and other developed markets, according to institutional asset managers and investors. 

PGIM — the investment management business of Prudential Financial — as well as State Street Global Advisors and even institutional investors themselves are hiring political risk analysts to gauge the potential effects of everything from possible trade wars to election outcomes on developed markets securities. 

Investors in emerging markets have historically had to worry about trade wars, unstable governments, and shaky political alliances, among other risks. But recent events in developed markets — the U.S. pulling out of the Iran deal, a brewing trade war between the U.S. and China, and the U.K.’s decision to leave the European Union — have changed that calculus.

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“We’re putting geopolitical risk analysis of developed countries front and center,” says Taimur Hyat, chief strategy officer of PGIM. “If you are an institutional investor you have to put it higher up on your list of things to look at.” 

Hyat says investors need to think through whether they hire political risks analysts themselves, determine whether they can rely on their external asset managers for advice, or hire third parties. 

The chief investment officer of a large foundation on the East Coast said the organization first started thinking about geopolitical risk in the developed world with the U.K.’s vote to leave the European Union and when nationalist candidates gained momentum in Europe, promising changes in foreign and other policies. At the time, the CIO says, the foundation didn’t have comprehensive information on the size and scope of the risks that it was facing with its developed markets equities and fixed income. 

The foundation recently hired a consulting firm to gauge the risks for its portfolio, rather than use analysts from its myriad asset managers, many of whom are still in the early stages of thinking through what geopolitical risks mean to investors in places like the U.K. 

Hyat says investors should make sure when selecting managers that political risks are actually considered as part of the investment process. The analysis isn’t always easy. 

“Sometimes we end up with views that are different from major credit ratings agencies on what is the risk in different countries,” he says.