New World Order Calls for New Assessments of Political And Social Risk
While opinions are more divided than ever, there is one item on which academics, pundits and investors can all agree: In just a few years, the political landscape has changed dramatically. The rules-based political order and its associated trading system, in place since the end of World War II, is rapidly evolving and can no longer be taken for granted.
In this changing climate, a sophisticated understanding of political and social risk - and how to assess it -has never been more important for investors. This is particularly true for real asset investors, as companies in these industries operate in countries where political and social risk is high.
As we explain in a recent primer, How to Think About Political & Social Risk in Equity Investing, the traditional model to assessing political and social risk has its shortcomings:
“For most, understanding political/social risk comes in the form of a third-party report that articulates ‘country risk’, which is to say a report with numerical rankings of qualitative factors, a broad summary of the political/social environment in a country at a high level and the obligatory near-term forecast, usually a mix of a general economic outlook and a political op-ed. In short, sometimes an interesting read but little else, and of very limited use to an investor.”
Assessing Management's Ability
Within the paper, we propose a new framework for assessing political and social risk. Specifically, assessing management ability to deal with such risks in real time. As we explain in the paper:
“We are not seeking to forecast the events that may occur; we are seeking a high conviction that management can deal with political/social events when they occur. If an investment is made with a medium to long term expected holding period, a political/social event that will impact company operations is almost certain to occur. As such, the ability to handle the fallout from such event is an essential skill of management.”
Assessing management’s skill at handling an event comes down to evaluating the company’s relationship with relevant stakeholders. Investors must assess how management is framing the debate around its company in a given country and whether stakeholders accept that narrative.
In an environment where political and social risk is increasing, management teams that can deftly manage stakeholder relationships may be creating a competitive advantage for their business.
To explore our full framework for assessing political and social risk, including examples of companies who are managing those risks well, we encourage you to download our paper, How to Think About Political & Social Risk in Equity Investing. The short read provides a valuable primer for assessing political risk. As the political landscape changes, evaluating those risks have never been more important.