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The perils of overstating political risk

Shockwaves around the world have made political analysis a must for investors in Asia. But is the really smart play to look beyond the short-term news flows and stick to fundamentals?
The perils of overstating political risk

With Donald Trump in the White House, multiple crises in Korea, controversial figures such as Malaysia's Najib Razak and Philppine president Rodrigo Duterte holding power in key Asian markets and yet another vote in the UK, political analysis is gaining new purpose among Asia's fund managers.

But is the importance of political risk being overstated? Is the smarter way to play the huge flow of political news simply to look beyond it and put faith in fundamentals?

Some experts believe political risks associated with investing have changed little over the years, and increasing market sensitivity to politics actually says more about the economy than those in power.

“There are always political events going on [in Asia], and that is the nature of investing in emerging markets,” said Joshua Crabb, head of Asian equities at Old Mutual Global Investors. “But people are getting more sensitive towards these events because we are at an inflection point of the economic cycle.”

Getting sensitive

Over the past few years the world economy has seen declining growth, low interest rates and low volatility. Global markets are on the verge of a seismic change as rates and inflation pick up. As a result, investors are growing more sensitive and tend to assign higher risk-premiums to political events, said Hong Kong-based Crabb.

Some of the blame can also be put on social media — even when Trump’s Twitter account is left out of the discussion.

“Social media has raised public awareness of political issues and events, which in turn, leads to more discussion,” said June Lui, a portfolio manager at BMO Global Asset Management. “The speed of how news and rumours spread is what makes political risk more prominent these days.”

Yet while political risks are always present, they are not necessarily any greater in Asia now than they were in the past, said Rick Mattila, international head of market strategy at MUFG Securities. “The most dramatic political events in 2016 were not in Asia, but in Europe and the US. This may also be the case in 2017.”

Staying ahead of the curve

Still, political developments are essential for investors — and a source of potential bragging rights between funds.

Thomas Poullaouec, Asia-Pacific head of strategy and research at State Street Global Advisors, said his firm started a politics and policy team in 2012, aiming to construct an in-house assessment framework to forecast the impact of politics on returns. It seeks to capture upside by “analysing what the market might be missing”, Poullaouec said. The team “looks at market consensus around a particular topic, and analyses whether they are too bullish or too bearish compared to our own assessments”.

This strategy paid early dividends, helping State Street to profit from Japan’s stock market rally, since the 2012 election after its analysis showed Shinzo Abe could be a “game-changer” as prime minister, Poullaouec said. “As a result we upgraded Japan to neutral and reduced our underweight positions.”

Fund managers’ interest in political analysis has been boosted by its potential for positive returns as much as for its ability to help avoid downturns. After a tumultuous year, policy and political risk analysis looks set to gain credence among Asian investors.

¬ Haymarket Media Limited. All rights reserved.
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