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Do Your Investments Have Political Risk Factors?
Dec 21, 2011
Risk is not necessarily a bad thing.
Every investment has risk. A common definition of risk is deviation from an expected outcome. That deviation can be positive or negative.
To achieve higher returns in the long term, investors generally must accept greater volatility in the short term. The amount of volatility an investor is willing to accept is often referred to as “risk tolerance.” Your capacity to accept volatility is based on your specific financial circumstances, while taking into account your psychological comfort with uncertainty and the possibility of incurring short-term losses.
- Credit risk is the risk of borrowers defaulting on their loan obligations.
- Market risk is the risk that the value of a portfolio will decrease due to market conditions.
- Liquidity risk is the risk that a given asset cannot be traded quickly enough in a market to prevent loss or make a profit.
Most investors associate the term “political risk” with stocks and bonds issued by non-U.S. corporations and debt issued by foreign governments. However, the U.S. portion of your portfolio may be every bit as susceptible to political risk as the international portion.
Political risk refers to complications businesses and governments may face because of what are commonly referred to as political decisions. Generally speaking, political risk is a risk that your investment objectives will not be achieved as a result of such nonmarket factors as changes in macroeconomic and social policies, as well as political instability.
While many U.S. investors normally associate political upheavals such as coups, civil wars and insurrection with third-world countries, and they may associate expropriations and currency devaluations with unstable economies, they don’t have to go beyond the borders of the United States to find evidence of political risk. This country has certainly seen its share of shifts in macroeconomic policies – think last summer’s debt ceiling debate; social policies – think the healthcare debate; and political stability – think the 2000 presidential election.
Here is a rundown of some political risk factors in the United States that investors should consider:
High unemployment – As President Obama, congressional leaders and Republican presidential candidates present dueling prescriptions to stimulate jobs growth, the risk of stagnation until after the 2012 presidential election looms large. The Federal Reserve has injected $2.3 trillion into the economy since late 2008 and has slashed interest rates to near zero. Will Chairman Bernanke act again in an effort to stimulate a sputtering economy by easing monetary policy?
Political rancor over debt and deficits – Will Democrats and Republicans find common ground for the $1.2 trillion budget gap that must be closed as a result of last summer’s debt ceiling compromise? To accomplish anything close to this goal, it appears that Democrats may have to renegotiate favored social programs, and Republicans may have to concede to tax increases.
Political gridlock – Can a Democratic White House and Senate find common ground with a Republican House of Representatives to move any significant legislation forward prior to the 2012 election?
Campaign 2012 – The president, one-third of the Senate and the entire House of Representatives are running for election in November 2012. What is best for re-election is more likely to affect the political compromises that are made – or not made – between now and next November, not what is best for the economy. Meanwhile, the Republican presidential contenders will jockey first for their party’s nomination and then for the presidential election. During the campaign, the Republican nominee and President bama will propose programs and make promises that they may or may not be able to pass or keep after the election.
China – How does China affect investment in the United States? China holds over $2 trillion of dollar-denominated assets, including U.S. Treasury bonds that were owngraded by Standard and Poor’s. Were China to significantly realign ts investment portfolio, other holders of U.S. government bonds would certainly feel the hockwaves.
Experts say the best way to manage risk in your investment ortfolio is through diversification. Most recommend some portion of your investments be in markets outside the United States.
Many investors view international investing as taking on an ncreased amount of political risk. Savvy investors understand that there is plenty of political risk right here at home.
Amy is more than an auditor for CFED. She is a valuable business advisor helping us navigate through complex regulations and opaque guidance.
Adnan Bokhari | Chief Financial Officer
The Corporation for Enterprise Development