Political risk has always been a fact of life for investors focused
on the developing world, but many money managers are now assessing
which countries have institutions and governments robust enough to
stop the kind of anger boiling over into the chaos seen after the
Arab Spring uprisings.
The emergence of what one investor called 'the Facebook Middle
Class' - aspirational but frustrated as elites soak up the gains
from economic growth - is creating a potentially explosive
environment in key economies such as Brazil and China, they say.
"This middle class is waking up to the fact that the government does
not offer you the schools, the roads, healthcare system, the housing
that the middle class around the world gets," said Jorge Mariscal,
UBS Wealth Management's chief investment officer of emerging
markets. "It is this phenomenon that is creating enormous amounts of
resentment."
The insurance market is showing clear signs that companies with
international operations are becoming more and more anxious about
social discontent in particular.
Insurers are seeing a spike in demand from companies looking for
policies to cover "soft" political risks - such as heavy handed
policy responses to civil disorder that damage business prospects -
as opposed to hard political risks like war, said Andrew van den
Born, the executive director in the political and trade credit risk
practice at insurance broker Willis.
"We’re seeing growth in soft risks – income disparity, poverty, food
prices," van den Born. "There’s been an upward trajectory in demand
for this product since the Arab Spring."
Credit insurer Coface, which covers companies against default by
their clients, has placed its ratings of Turkey and Venezuela on
'negative watch' reflecting "political fragility". Both have seen
civil unrest.
Global managers of stocks and bonds are also growing more aware of
the roots and results of such social tension. They see the extent to
which it depresses economic growth over time and undercuts long-term
returns.
Some of them are increasingly looking at which governments are
capable of reforming fast enough to defuse political tensions. Among
them is Andrew Milligan, head of strategy at Standard Life
Investments (SLI), the Edinburgh-based asset manager.
He reckons Mexican bonds remain highly investable. But SLI has a
'zero weight' on credit from Brazil, the scene of street protests,
where the results of an upcoming election are difficult to call.
"Political unrest is another reason for us to be cautious... These
issues often lead to outflows, or insufficient inflows. They often
are associated with currency problems and that’s not very helpful,"
he said.
Rapid growth in the developing world has drawn millions out of
poverty and created a new middle class, but inequality has
simultaneously increased in countries such as China and India, the
Organisation for Economic Cooperation and Development said in a
report published earlier in July.
The resulting social tensions threaten to "hamper growth and lead to
instability," the OECD said.
Carl Dahlman, the head of global research at the OECD's Development
Centre, warns the rising tensions endanger the flow of foreign
investment, jeopardizing economic growth further still.
"When (investors) begin to see social tensions rising you do see a
fallback in investment ... There's a lot of animal spirit in these
things," he told Reuters.
Investors also note that qualitative factors such as institutional
or government stability must be taken into account. Quantitative
measures of inequality are not enough in isolation.
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The most closely watched measure of equality used by economists -
the Gini Coefficient used by bodies such as the World Bank and OECD
- show income inequality is wider in Nigeria than in France, for
example. But it also shows Belarus and Japan have among the most
even distributions of income in the world, although they offer very
different investment prospects.
"It is a part of the mosaic, certainly... But there are a lot of
factors at play here," said Morgan Harting, portfolio manager for
emerging markets at AllianceBernstein.
The world's biggest asset manager, Blackrock, produces a Sovereign
Credit Risk Index for investors, 30 percent of which is made up of
the category 'willingness to pay' - an assessment of a government's
effectiveness and stability - alongside conventional quantitative
measures.
Alastair Newton, a senior political analyst at Nomura, identifies
civil unrest seen over the past year in a long list of countries,
including Brazil, Chile, Egypt, Thailand and Turkey as "a
quasi-systemic threat," and places it high on a list of "issues
which keep me awake at night."
"You know that something bad could happen in any number of
countries, but you don’t know what and you don’t know when," he told
Reuters. "And even if you did, you’d probably struggle to price it
in."
OPPORTUNITIES
Not all investors are so gloomy Some argue that this middle class
agitation in Turkey, Brazil or Chile should be seen as growing pains
associated with a process that is overwhelmingly positive.
Masha Gordon, London-based Head of Emerging Market Equities at PIMCO,
argues investors should also be heartened by events in India, where
the election in May of a reform-minded government, has shows the new
middle classes can spur change for the better.
"This should give hope. Places stuck in a middle-income transition
need to do structural, difficult reforms ... The externality of a
so-called demographic dividend is a generation that is looking to
vote out policy makers who failed to deliver the benefits from
economic expansion."
May's election result has driven sharp rises in Indian asset prices.
Mumbai's benchmark BSE equities index reached record highs this
month, after rising more than 15 percent since the election.
The resentment that UBS Wealth Management's Mariscal saw also
represents an opportunity, he said - an opportunity to invest in the
infrastructure projects, hospitals and healthcare facilities
protesters are demanding.
"It’s an interesting theme for us ... a medium-term investment theme
that needs to be explored," he said.
(Reporting by Chris Vellacott; Editing by Larry King)
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