How to Manage Political Risk

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This article will show you how to minimize and deal with political risk when investing.

Consider insurance as one option in political risk management, but in contrast to other financial risks, it is not the only step. Indeed, insurance is only a viable option to protect against micro-level risks; macro-level risks are too catastrophic for insurance to defend against. To that end, even insurance against micro-level risks is incredibly expensive. It is best used as an absolute fail-safe, in combination with other, more proactive political risk management strategies.

Be proactive and avoid situations with overt risk. The largest companies employ a professional chief risk officer whose sole responsibility is to stay on top of potential risks, such as insecure political climates, new legislation and elections among other. Smaller companies leave this responsibility to the chief financial officer, but either way, there is always someone who is responsible for managing risks. Careful, thorough examination and analysis of situations is key to avoiding political risk by eschewing investment in areas that are too risky and pulling money out of areas when they become too risky.

Deal with risks as they come. Management is not avoidance; you are going to need to come to terms with the fact that you won't be able to predict every political risk. Consequently, you're going to need to have exit strategies and alternative investment options, as 100 percent crisis avoidance is simply not possible, especially as you invest more and more money in more and more sectors.

Know the difference between the micro and macro level. Micro level risks affect your industry or your project; macro level risks affect the entire economy. Micro level risks can be dealt with far more easily as they come--your investment can be shifted to a different industry, you can find a new local partner, and, if worst comes to worst, you can file an insurance claim. Macro-level risk, however, is the variety that you need to see before it comes because if the nation in which you are investing closes its borders, devalues its currency or becomes insolvent, you and your money are left with very few options.

Diversify. The basic tenets of investment are simple and universal, and as such they apply in this situation too. If you are investing overseas, don't put all your eggs in one unstable basket. Spread your money out so that political risk affects just one part of your investment at a time. This is the most important step in avoiding risk--political or otherwise--when investing.

Tips & Warnings

  • Think ahead. Get insurance. Understand your investment. Diversify.
  • Choose your markets carefully. Do your research. Be wary of local partners, especially if you're rarely on-site.

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