The risk in risk indices

The risk in risk indices
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First Published: Wed, Aug 29 2007. 12 25 AM IST
Updated: Wed, Aug 29 2007. 12 25 AM IST
With large financial investments being made by fund managers in the hope of booking regular profits by transferring money from one market to another or allocating funds proportionately, risk indices offer a safe benchmark. Many would argue that prudent investments have benefited from country risk profiles in the form of quantitative indices, including the GPRI. But a correlation between risk profile, investments, hedging and profits has yet to be established. Prudent financial managers follow distinctive parameters, including the proverbial instinct, be it the contrarian mood of Marc Faber or the ear to the ground approach of Rakesh Jhunjunwala in India.
Where investments worth crores of rupees are at stake, particularly in the small gain, large loss environment of emerging economy markets, numerical indices may inadequately represent country risk. Given the wide variation in compilation of indices and the manner in which they are represented, there is need to debate the veracity of conclusions drawn by armchair analysts who depend on expert opinion from varied sources—more so as the indices are being marketedcompetitively.
Consider the wide variation in indices such as the Global Peace Index published by the Economic Intelligence Unit which places India at 109, sandwiched between Myanmar and Uzbekistan in a group of 121 states, or the Failed States Index, where India is not in the first 60 states most likely to fail. On the other hand, one local study places India as the fourth most secure state in the world. Whom do you believe, the surveys by well-established opinion makers of the West or the more down-to-earth view from India?
Particularly in politically volatile countries—and democracies are the worst affected by this—accurately factoring in episodic political events is very tough. So, how does one rate India before the ultimatum given by the Left parties to the UPA government on Saturday and after it? Would the rating fall substantially given that political uncertainty may continue not just in the short term, but also in the medium term, until after the next general elections? This could well be as close as three months or even as far away as two to three years.
Political and security risk trends may be better markers. An empirical analysis of past events extrapolated over predicted events in the future may indicate potential stability-instability criteria in a state. Trend analysis is a powerful tool which can suggest corrective measures to overcome possible challenges and for derisking. For instance, in high security risk states such as Iraq and Afghanistan, there are many lucrative investment opportunities, each with a corresponding risk to personnel as well as possible loss of business. Having identified this trend, with adequate buffers for personnel and business insurance, de-risking can be done to seek wholesome profits.
Such opportunities may not be evident if one goes by an index based assessment. Trend analysis can also envisage situations emerging over the medium and long term far more accurately. For instance, in Bangladesh which is undergoing major political and economic restructuring, if the caretaker administration succeeds in establishing an elected government, the economy is likely to see an upsurge in 2009-10. Prudent investors may consider tracking the trend and be ready to invest in Dhaka at that time. Purists may say trend analysis suffers from lack of quantified inputs which most large investors prefer while comparing two or more markets, but it avoids the perils of judgemental hypothetication from statistical inferences, particularly for those who are uninitiated to an index.
(Rahul K. Bhonsle is security analyst and editor, South Asia Security Trends, a monthly journal. Comments are welcome at otherviews@livemint.com )
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First Published: Wed, Aug 29 2007. 12 25 AM IST
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