As you grow your investment portfolio, you may start looking into diversification with unique investments like junk bonds or dividend stocks. One of the best ways to diversify a portfolio is international investing. However, choosing to purchase stocks or bonds from different countries comes with varying risks, so it is important to account for this as you make investment decisions.
One concept you should know is country risk, which refers to the economic and political conditions of a certain jurisdiction and how they may affect business that takes place there. Of course, these risks evolve over time, so the risk 10 years ago for a country likely does not look like the risk that exists today. Thus, country risk is something that needs to be monitored and managed over time. Of course, you need to understand how to measure country risk in the first place.
Quantifying Country Risk for International Investments
The process of measuring risk for a specific country can be extremely tricky. In general, investors need to take hundreds of different points into account, from political movements to tax laws. These points may change at any given moment as new groups take power or interest rates change. A simple change can have a dramatic effect on a country’s stock market and business landscape. At the same time, something as small as a statement from a political official can have a major impact. To begin breaking down this complicated task, most people divide country risk into economic and political risk. Economic risk refers to a country’s ability to repay its debts and its overall financial stability. Political risk involves the politicians that lead a country and the impact their decisions may have on investment.
An example of economic risk is a country’s existing debt. If the debt a country carries is much higher than its gross domestic product, then the country may struggle to raise money to support itself. This means that the country may be less likely to repay debts.
Political risk would include new leaders who want to grow certain industries, perhaps to the detriment of other industries within the nation. Often, economic and political risks become intertwined. Politicians may implement policies that undermine the economy, such as spending money from foreign reserves. Thus, the distinction is not always the most helpful.
Analyzing the Risk Involved with Foreign Investing
Beyond quantifying the risk of investing internationally, you need to be able to analyze it. Investors use several different tools to complete this analysis, including beta coefficients and sovereign ratings. In reality, people should use a combination of different tools to analyze country risk and how it impacts the risk involved with a particular investment or security.
There are both quantitative and qualitative approaches to risk analysis. For the most part, quantitative analyses use ratios or statistics. You can find the hard data you need to complete these analyses through various rating agencies, financial information providers, or publications. Qualitative analysis uses more subjective information like news articles or opinion pieces in reputable sources like The Wall Street Journal.
Perhaps the most common strategy for assessing country risk is the use of sovereign ratings. Agencies consider both quantitative and qualitative data to create credit ratings for each country. These ratings are useful because they allow for direct comparison between countries, which can be particularly helpful when you are deciding between investment options. There are many ratings agencies, but the most popular are Standard & Poor’s, Fitch Ratings, and Moody’s Investor Services.
Investigating Country Risk as an Individual Investor
Beginner investors can quickly become overwhelmed by the amount of information available to them when it comes to determining country risk. A great place to start is with sovereign ratings through one of the previously mentioned agencies. This information provides you with a baseline for the level of risk. Once you have established this baseline, be sure to watch for any negative updates in the news that might affect the ratings.
Search Google News or an international news aggregator on the country in question to get some more qualitative data. In addition, you could look at some public data sources like the World Bank or the International Monetary Fund. You will also need to do some quantitative work to get a full picture of risk. A beta coefficient is usually sufficient. A higher beta coefficient for a country implies greater risk.
Importantly, a nation with high country risk is not necessarily problematic. For example, countries undergoing significant economic reform tend to be very risky during that period but may have a bright long-term future. As you decide on international investments, you should additionally consider how the particular asset would add to diversification. Also, remember that you need to keep a very close eye on international investments because situations can change rapidly in these markets, which is especially true with the riskier ones. When you start to see indications that problems are on the horizon, then it is time to decide if you want to ride out the storm or try to sell.