International investing is a great way to diversify any stock portfolio. But investing in Italy or Nigeria isn't the same as investing in the United States. Country risk refers to a country's economic and/or political risks that may affect its businesses and result in investment losses. In this article, we'll take a look at how to quickly and easily measure and analyze country risk.
Measuring Country Risk
Measuring a country's risk can be a tricky endeavor. From tax laws to political upheaval, investors have to take hundreds, if not thousands, of different factors into consideration. For instance, solid moves like a hike in interest rates can dramatically help a country's businesses and stock market. But even a mere comment from a prominent politician hinting at future plans can have just as large of an impact.
A country's risk can generally be divided into two groups:
- Economic Risk: Risk associated with a country's financial condition and ability to repay its debts. For instance, a country with a high debt-to-GDP ratio may not be able to raise money as easily to support itself, which puts its domestic economy at risk.
- Political Risk: Risk associated with a country's politicians and the impact of their decisions on investments. For instance, desperate politicians supporting nationalizations could pose a risk to investors in certain strategic industries.
Analyzing Country Risk
There are many different ways to analyze a country's risk. From beta coefficients to sovereign ratings, investors have a number of different tools at their disposal. International investors should use a combination of these techniques in order to determine a country's risk, as well as the risk associated with the international investment/security itself.
Methods used to assess country risk can be grouped into two categories:
- Quantitative Analysis: The use of ratios and statistics to determine risk, such as the debt-to-GDP ratio or the beta coefficient of the MSCI index for a given country. International investors can find this information in reports from ratings agencies, magazines like the Economist, and through various online sources like Wikipedia.
- Qualitative Analysis: The use of subjective analysis to determine risk, such as breaking political news/opinion or realistic market rumors. International investors can find this information in financial publications like the Economist and the Wall Street Journal, as well as by searching on international news aggregators like Google News.
But, the most common way that investors assess country risk is through sovereign ratings. By taking these quantitative and qualitative factors into account, these agencies issue credit ratings for each country and give investors an easy way to analyze country risk. The three most-watched ratings agencies are Standard & Poor's, Moody's Investor Services, and Fitch Ratings.
Country Risk Checklist & Other Tips
International investors can determine country risk using this simple three-step process:
- Check Sovereign Ratings: Look-up the country's sovereign ratings issued by the S&P, Moody's and Fitch to get a base-line look at the country's level of risk.
- Read the Latest News: Search on Google News or other international news aggregators for any economic news surrounding a country as a form of qualitative research.
- Check the Stock's Risk: Determine the specific investment's risk by looking at quantitative factors, such as the beta coefficient - a higher beta coefficient equates to greater risk.
But just because a country is risky doesn't mean investors should ignore it. Sometimes increased risk equates to higher potential returns. For instance, a country undergoing an economic reform may be riskier now, but its long-term future may be brighter as a result. International investors can therefore still incorporate risk into a diversified portfolio in order to enhance potential returns.
Here are a few tips to keep in mind when considering riskier investments:
- Stay Diversified: A diversified portfolio can help mitigate the effects of any one security falling sharply. Try and limit any one security from accounting for more than 5% of a portfolio's value.
- Hedge Your Bets: Some strategies, such as writing covered calls or buying index put options, can help hedge against a market downturn. Advanced investors may want to consider these options.
- Monitor the Situation: Always keep an eye on your investments. Things can change rapidly in international markets - particularly risky ones - so make sure you see any dark clouds before the storm hits.