The most simple way this is implemented is by selecting target countries deemed for investment because of their general risk configuration.Another common analysis of an investment includes building an earnings projection and producing a discount rate. The discount rate is where the risk is accounted for and it is built by adding to the comparable rate from a US company, a "country risk" factor based on the sovereign spread over treasuries.
However, this represents an oversimplification of the risks associated to investments, mainly: Firm Risk, Macroeconomic Risk and Political Risk.
However, this represents an oversimplification of the risks associated to investments, mainly: Firm Risk, Macroeconomic Risk and Political Risk.
I have little objections to the analysis of firm risk per se since it is not where the country risk usually comes in. However, the interaction between certain sectors/ firms and other risks should be accounted for.
When investors usually talk about investing in a country, its Macroeconomics are the first thing they look at: GDP growth, Inflation, Real Interest Rate, Probability of Default, etc. However, not every company is equally exposed to these macro trends.
For example, exporters have little exposure to the local GDP, but are exposed to the volatility of the Real Exchange Rate. Even within exporters, Capital or Land intensive companies -i.e. Farms, Metals- are less exposed to Exchange Rates than Human Capital intensive companies -i.e. Business Process Outsourcing-.
Also, the cash flow stress associated to this risk can be stabilized by hedging in the financial markets; but markets are not deep enough to hedge currency or GDP risk for long periods.
To sum up, Macroeconomic risk is based on the company´s exposure to a local economy which is not necessarily only the country where it produces and the risk can be reduced (or exacerbated) by correctly managing it in the financial markets.
Political risk is even more subtle since a company is evidently exposed to the local politics that can expropriate, tax, regulate, declare war, etc. Some extreme events, like war, affect every company alike but are very unusual and have barely ever occurred in Latin America in the past 3 decades.
The main political risk in Latin America is a market disruption (expropriation, regulation, tax), that is why the most "market friendly" governments in the region are the ones foreign investors usually target. This targeting has three main shortcomings.
Firstly, this analysis overestimates the duration of the political processes in Latin America, extrapolating current government behavior into future decisions.
Also, even if market friendliness is a good proxy for political risk, it overlooks some other associated risks. For instance, Peru and Colombia are the new vedettes of the Latin Financial Markets for their market-oriented governments and their high growth rates. However, in Perú police brutality is a big problem and in some regions in Colombia security risk is still an issue.
Finally, the political risk in every sector and industry is very different in each country. For example, Brazil has more political risk than Chile; but investing in Apparel Retailing in Brazil has much less political risk than investing in Copper Mining in Chile; not only for Copper´s general political risk, but for its cornerstone role in the Chilean Economy. There are differences even within mining: being a supplier to mining companies is a much safer bet than being directly involved in the industry.
In conclusion, yes there are some countries that are more risky than other, but the risk of a company or project should be fully analyzed without simplifications and investors should focus on the level of each risk they are willing to take.
PS: Thks to James Knight of Pionero Partners for his input
For example, exporters have little exposure to the local GDP, but are exposed to the volatility of the Real Exchange Rate. Even within exporters, Capital or Land intensive companies -i.e. Farms, Metals- are less exposed to Exchange Rates than Human Capital intensive companies -i.e. Business Process Outsourcing-.
Also, the cash flow stress associated to this risk can be stabilized by hedging in the financial markets; but markets are not deep enough to hedge currency or GDP risk for long periods.
To sum up, Macroeconomic risk is based on the company´s exposure to a local economy which is not necessarily only the country where it produces and the risk can be reduced (or exacerbated) by correctly managing it in the financial markets.
Political risk is even more subtle since a company is evidently exposed to the local politics that can expropriate, tax, regulate, declare war, etc. Some extreme events, like war, affect every company alike but are very unusual and have barely ever occurred in Latin America in the past 3 decades.
The main political risk in Latin America is a market disruption (expropriation, regulation, tax), that is why the most "market friendly" governments in the region are the ones foreign investors usually target. This targeting has three main shortcomings.
Firstly, this analysis overestimates the duration of the political processes in Latin America, extrapolating current government behavior into future decisions.
Also, even if market friendliness is a good proxy for political risk, it overlooks some other associated risks. For instance, Peru and Colombia are the new vedettes of the Latin Financial Markets for their market-oriented governments and their high growth rates. However, in Perú police brutality is a big problem and in some regions in Colombia security risk is still an issue.
Finally, the political risk in every sector and industry is very different in each country. For example, Brazil has more political risk than Chile; but investing in Apparel Retailing in Brazil has much less political risk than investing in Copper Mining in Chile; not only for Copper´s general political risk, but for its cornerstone role in the Chilean Economy. There are differences even within mining: being a supplier to mining companies is a much safer bet than being directly involved in the industry.
In conclusion, yes there are some countries that are more risky than other, but the risk of a company or project should be fully analyzed without simplifications and investors should focus on the level of each risk they are willing to take.
PS: Thks to James Knight of Pionero Partners for his input
No comments:
Post a Comment