Political Risk – An Important Issue for Sovereign Wealth Funds

by Dr. David A. Glancy

Political risk is any event that can directly or indirectly alter the value of an economic asset. This definition is quite broad but it is important for investors to understand all the ways that political risks can affect an investment and not just focus on those events that make the news. Political risk includes everything from government actions (expropriations and breaches of contract, discriminatory taxation) to geopolitical events (international wars, terrorism) and social-economic changes that can lead to social unrest.

Sovereign Wealth Funds (SWFs) are in a unique position when it comes to political risk issues. SWFs face all of the political risks that other financial firms and hedge funds face when investing around the world but because they are government owned entities, their investments in target countries are subject to additional scrutiny and political risks that private sector actors do not face. Government ownership can also lead to pressure on SWF management teams to limit losses (and achieve appropriate returns) and restrict some SWF investment options such as the ability to short equities. To their benefit, most SWFs are long-term investors which provides an advantage — they can ride out short-term downturns and, in some circumstances, invest in assets that are riskier in the short- to mid-term. SWFs have not been immune to the political events noted above.

SWFs have taken measures to protect their investments by diversifying their portfolios but they will need to incorporate political risk analysis into their investment strategies to better protect investments and maximize returns.

Political Risk – An Important Issue for Sovereign Wealth Funds