Stockpicking in a political economy

Hermes Sourcecap’s Andrew Parry sees stockpicking as a way to handle political risk and outperform the market.

Historians say that high male youth unemployment and bad harvests (or food scarcity) are the two factors that cause social tension. Combined, they say, the two factors are a recipe for evolution and civil war.

From being an academic curiosity, this theory looks alarmingly as if it could become an actual fact, something that is focusing the minds of fund managers today. Spain and Greece are facing a cocktail of high youth unemployment (in Spain, it is currently 55%) and food rice inflation. Already the social tensions have made headlines across Europe.

Risk upgraded

For fund managers, political risk used to concern only developing economies. The new reality is that political risk now concerns developed economies too and ranks alongside that of other traditional economic measures when making investment decisions, such as mean reversion and efficient market theory.

A report from Hermes Fund Managers says: “Investors have tried to incorporate an element of geopolitical risk assessment in emerging markets investments, but it has been at least two generations since they looked at the issue of political risk in the context of developed economies.”

Saker Nusseibeh, chief executive and head of investment at Hermes Fund Managers, says: “In the history of developed markets, political risk was once the norm, but faded as an investment consideration post-World War II. The period of great stability that followed was, in part, because the subsequent Cold War provided developed nations a common, external adversary to worry over.

With no common ‘enemy’ anymore and mounting internal concerns, the idea that we are all friends in the West is dwindling.”

In the EU, Nusseibeh says, structural flaws and varied national interests are leading to increased tensions between EU member countries, similar to those seen in the 19th century.

“In this environment, politics can have as much impact on the attractiveness of different markets as GDP figures,” as embattled governments turn to protectionism and capital controls to protect their national interests,” he says.

“What is clear is that we are now approaching an era when investment decisions cannot be made without incorporating political risk into the equation. The way we approach nvestments has to change. The investment world must wake up to the fact that we do not operate in a hermetically sealed financial system; we now live in a political economy.”

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