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3 Ways You Can Evaluate Country Risk

14 Oct

For many investors, investing  internationally is an attractive way to gain additional diversification  and increased return for their portfolios. At the same time, however, many find  it hard to invest abroad due to lack of experience, unfamiliarity with the  foreign country and excessive amounts of information to analyze. To alleviate  some of these difficulties, we’ll look at a couple ways to help you more easily evaluate  the degree of risk in a country’s fundamentals.


Where  Does Sovereign Risk Fit?
Analyzing sovereign  risk factors is beneficial for both equity and bond investors, but perhaps more directly  beneficial to bond investors. When investing in equity of specific companies  within a foreign country, a sovereign risk analysis can aid in creating a macroeconomic picture of the operating  environment, but the bulk of research and analysis would need to be done at the  company level.
On the other hand, if you’re investing directly into a  country’s bonds, evaluating the economic condition and strength of the country  with these methods can be a good way to evaluate a potential investment in  bonds. After all, the underlying asset for  a bond is the country itself and its ability to grow and generate revenue.

Often, the most common method used by  investors, with time or resource restrictions that don’t allow them to do the  analysis themselves, is to rely on experts who spend all their time doing that  type of analysis. Calculating debt  service ratios, import/export ratios, money supply changes and all those other  fundamental aspects of a country, and attempting to incorporate them all into  the big picture, requires a significant commitment if you do it by yourself.  Thus, it is recommended against in favor of a number of easy-to-understand  indicators. Sourcing these tools from organizations focused on analyzing country risk allows more energy to be  focused on investing.

Euromoney Country Risk The  first tool that can be used to evaluate sovereign and political risk is the  Euromoney Country Risk survey. The ECR survey covers 186 countries and gives a  comprehensive picture of a country’s investment risk. The rating is given on a  100-point scale, with a score of 100 representing virtually zero risk.

In  general, the calculation of the ECR rankings is split between two overall  factors – qualitative (70%  weighting) and quantitative (30%  weighting). The qualitative factors are derived from experts who assess the  political risk, structure and economic performance of the country. The  quantitative factors are based on debt indicators, capital market access and  credit ratings. The rating for the qualitative and quantitative factors are  available separately, so if you believe the weighting importance to be different  than 70/30, you have the flexibility to manually adjust the weighting  yourself.


The Economist Intelligence Unit
The next popular credit rating information source is the  Economist Intelligence Unit (EIU). The EIU is the research arm of The  Economist and one of its best offerings is its Country Risk  Service ratings. These ratings cover over 100 countries, with an emphasis  on “emerging and highly indebted”  markets. The rating analyzes factors similar to the ECR rating, such as economic  and political risk, and provides a rating on a 100-point scale; however, unlike  the ECR rating, higher scores mean higher sovereign risk.

A benefit of the EIU ratings is that they  are updated on a monthly basis so trends can be caught much earlier than other,  less frequently updated methods. In addition, the EIU format offers investors  more analysis and provides an outlook for the country as well as two-year  forecasts for several key variables. So if you want to get a sense of the  direction a particular country is headed in for in the near future, this may  prove to be a useful tool.
Below is an example of the EIU ratings of a  handful of high-risk countries in early 2011.

Data source: http://www.eiu.com, August 2012

Country Credit Survey (Institutionalinvestor.com) The third  method, the Country Credit Survey, is also a rating service based on a survey of  senior economists and analysts at large international banks. The uniqueness of  this approach is appealing because it surveys people from companies that are at  the ground level, lending and providing capital directly to these countries. In  a sense, this adds a degree of credibility to the ratings because major  international banks typically do a significant amount of due  diligence before exposing themselves to certain countries.

Similar to  the other approaches, this rating is based on a scale of 0 to 100, with 100  being virtually risk-free and zero being equivalent to certain default. For  example, in March 2011, economists and analysts surveyed at major banks and  securities firms assessed that Norway was the country with the lowest  probability of default, with a score of 95.2. Meanwhile, they also assessed that  Somalia had the largest probability of default, with a score of  3.9.


The Bottom Line is
For investors  who have limited time and resources but want to diversify internationally, these  methods can be a great help to create a short list of countries that you may  want to invest in. Each method has its strengths and weaknesses, but it might be  best to use a combination or all of these popular data sources for country risk.  Each method can provide a unique perspective for the  investor.

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3 responses to “3 Ways You Can Evaluate Country Risk

  1. Mhina

    October 14, 2012 at 5:07 pm

    Thanks Monica….

     
    • monfinance

      October 14, 2012 at 5:12 pm

      You welcome Mhina, Stay around.

       
      • Mhina

        October 14, 2012 at 5:23 pm

        Am here around my dada, trying to get these hots….

         

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