Thursday, November 6, 2014

Risk management series: Country Risk

Hey, how are you doing? I’m quite happy that the Republicans took control of the senate as they generally fuck up less when it comes to the economy as compared to the democrats. In this article I will talk about things I look at when investing in foreign countries. To be honest, there are not many things I look at when evaluating country risk. However, I still think country risk is very important and that an investor can lose a lot of money if he doesn’t pay attention to this risk (speaking from personal experience here).

Update on the Greedy Dragon portfolio: I recently bought shares in Mongolia Growth Group (stock code: YAK). The company owns real estate in Mongolia.

Government debt-to-GDP ratio and budget deficits: I try to avoid developing countries with high government debt-to-GDP ratios and/or large budget deficits. A high debt country might default on its debt which will probably result in it entering an economic crisis. I’m more tolerant of developed countries with a high debt-to-GDP ratio as those countries have an easier time rolling over their debts and investors are less likely to pull out their investments from developed countries. However, investors should still try to avoid investing in developed countries with too much debt and wide budget deficits as those countries might still experience a debt crisis; the European sovereign debt crisis is evidence of that. Since a lot of developed countries have high government debt-to-GDP ratios, investors need to use their judgment to decide whether a specific developed country is able to service its debts or if it will turn out to be a deadbeat.

Other than government debt, investors might also want to look at a country’s consumer debt and corporate debt.     

Inflation: Investors should be cautious of countries with high inflation. Companies operating in countries with high inflation face rising input costs which they might not be able to pass on to the customers. A company’s profits will be affected if it can’t pass on its higher input costs to customers. It’s also not enough for businesses operating in a high inflation environment to just maintain its profits; those businesses need to grow their profits in-line with the rate of inflation or risk impairment to their value in real terms.

Note: Whether a company is operating in a country with high inflation or a country with low inflation, I generally look for companies which I think can grow profits faster than inflation over the long-term.

Political risk: Expropriation of assets and a lack of property rights, disastrous government policies, capital controls and wars are some of the political risks investors need to watch out for. I don’t have a system to analyze political risk. I basically just Google stuff and visit the Heritage Foundation website when I’m trying to get a better picture of a country’s political risk or economic freedom.

While country risk is important to consider, I do invest in stocks from countries with problems if I think the expected returns will compensate me for the risks I’m taking. However, there comes a point where you just say fuck it and walk away because a country is so messed up, regardless of how cheap assets in that country appear to be. Thank you for reading. Take care and stay rational.

1 comment:

  1. eToro is the most recommended forex broker for beginning and advanced traders.