Understanding Political Risk: How Geopolitical Changes Impact Your Investments
Explore the concept of political risk and how shifts in government policies and geopolitical instability can influence your investment returns. Learn strategies to mitigate these risks effectively.
Andy Smith is a Certified Financial Planner (CFP®), licensed realtor, and educator with over 35 years of extensive experience in financial management. He specializes in personal finance, corporate finance, and real estate, helping thousands achieve their financial objectives throughout his career.
What Exactly is Political Risk?
Political risk refers to the possibility that an investment’s returns may decline due to political changes or instability within a country. Such instability can arise from shifts in government leadership, legislative changes, foreign policy decisions, or military interventions. Often called "geopolitical risk," this factor becomes increasingly significant over longer investment horizons and is a subset of jurisdictional risk.
Breaking Down Political Risk
Quantifying political risk is challenging because of limited historical data specific to individual nations. While some political risks can be mitigated through insurance offered by international organizations or government agencies, the consequences can severely impact investment returns or even restrict the ability to withdraw invested capital.
Common Types of Political Risks
Beyond market-driven influences, businesses face risks from governmental decisions that affect industries and economies at large. These include changes in taxation, government spending, regulations, currency exchange rates, trade tariffs, labor laws like minimum wage standards, and environmental policies. Even proposed laws can influence business operations. Regulations may be enforced at federal, state, local, or international levels.
Investors can often identify political risks through company disclosures in filings with the Securities and Exchange Commission (SEC) or mutual fund prospectuses.
Mitigating Political Risks Through Insurance
Multinational corporations can purchase political risk insurance to protect against losses arising from political events. This insurance helps businesses focus on their core operations by minimizing potential financial damage caused by war, terrorism, or governmental disruptions.
Real-World Example: Wal-Mart's Political Risk Assessment
In its 2015 fiscal year 10-K SEC filing, Wal-Mart Stores Inc. detailed various political risks affecting its operations. The company highlighted concerns about political and economic instability in countries where its foreign suppliers operate, labor disputes, and the impact of foreign trade policies and tariffs.
Additionally, Wal-Mart discussed regulatory, compliance, reputational, and political-economic risks, including legislative and judicial uncertainties, product safety, environmental laws, tax regulations, labor laws, trade policies, and currency controls—specifically citing the complex regulatory environment in Brazil across federal, state, and local levels.
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