Alison Adams, PhD

1
Portfolio Investing and Political Risk in
Emerging Markets

• Alison Adams, PhD
• Boston Economic Club
• June 10th, 2009

2
Use Political RiskRather than Manage it

• In a reactive sense, political risk has been seen
  as something to be avoided or managed
• For dedicated portfolio investors, political risk
  can be anticipated and exploited for enhanced
  returns
• Getting ahead of planned and unplanned events is
  the key

3
Structures and Style vs. Expertise

• Expertise is particularly useful for FDI, company
  specific intelligence, and lobbying.
• Upside detailed analysis, sense of proximity to
  power, networking
• Downside too close to the subject, often biased,
  and unduly pessimistic, experts have a bunker
  problem and often do not have a sense of scale
• Research shows that experts have a poor record
  for predictions about subjects they know very well

4
Structures and Style Foundations for Using
Political Risk

• Political Structures
• Upside timing and rules, facilitates comparison
  with peers, facilitates organization and ranking
  of detailed information
• Downside can be too broad, can encourage over
  confidence
• Political Styles
• Upside preparation for unscheduled events,
  facilitates comparison, anticipate policy
  decisions
• Downside can be too broad, encourages over
  confidence, style can be malleable.

5
Non-tradable Political Risk

• Strategic risk tends to be slow moving and not
  conducive to an investment strategy. For example,
  N. Korea, Iran, and Russian expansionism
• Terrorism tends to be opportunistic and impact
  is local and temporary. For example, bombings in
  India, Turkey, and Thailand
• Extremely important for governments but not
  necessarily for economic performance

6
Tradable Political Risk

• Scheduled events and anticipated volatility
• Local and national elections
• Summits
• Unscheduled events and reactive investing
• Protests and popular unrest
• Government collapse
• Scandal and corruption

7
Political Structures

• Parliamentary Systems
• Presidential Parliamentary Systems
• Presidential Systems
• Each structure affords different investment
  opportunities for the portfolio investor in the
  form of contrarian views and appropriate risk
  aversion.

8
Parliamentary System

• Parliamentary systems are generally
• Low risk and slow to change
• Coalition governments disperse ministries
  according to interest. i.e. the Left gets the
  Labor Ministry
• Take alarmist views with a grain of salt. For
  example, the recent election in India
• I would generally view long positions as secure

9
Presidential Parliamentary Systems

• Range from benign to unstable a case by case
  reading is necessary
• President versus Prime Minister is unstable
  Ukraine
• President with the Prime Minister is stable
• Turkey-before and after President Gul

10
Presidential Systems

• Presidential systems can change direction
  substantially in a winner take all context
• Regime change can be deep in key ministries
• Business/government relationships vulnerable
• Polling is crucial to determine long short
  decisions
• Big bets are possible Brazil and Lulas first
  term AMLOs loss in Mexico

11
Political Style

• Why it matters for policy analysis
• In opaque policy situations, political style is a
  powerful guide to anticipate policy decisions.
  i.e. Ecuadors default
• Rule of law is not clear but style is clear. i.e.
  Putin and TNK-BP Erdogan in Turkey
• It matters to the politicians themselves and
  defines limits of loyalty and discipline. i.e.
  ANC National Executive Committee in South Africa

12
Debunking Political Assumptions

• In Emerging Markets all political parties
  believe in state sponsored growth to one degree
  or another.
• At this point, most political parties are
  reasonably market friendly. (Ignore swing to the
  left labels)
• What matters most is the quality and quantity of
  technocrats and willingness to establish best
  practices. AKP in Turkey, PAN in Mexico

13
Anticipating Policy Change

• Not an exact science but there are clear
  tendencies.
• Transparent democratic processes produce more
  populist policy
• Opaque committee processes produce more balanced
  results
• Civil Law tradition courts usually do not make
  new law a notable exception is Turkeys
  Constitutional Court
• Presidential decrees will be arbitrary and
  difficult to anticipate. i.e. Argentina and
  Venezuela
• Rent seeking behavior around natural resources is
  inevitable.

14
Conclusions

• It is possible to use political risk to maximize
  returns
• Political risk is endogenous to emerging markets
• Risk must be put in a relative context
• Not all risk is tradable
• Presentation is available at www.alisonadamsllc.co
  m