The Theory and Practice of Investment Management: Asset Allocation, Valuation, Portfolio Construction, and Strategies, Second Edition

INTERNATIONAL INVESTING AND POLITICAL EXTERNALITIES

The actions of government officials and officials of regulatory bodies and agencies can shift market expectations quickly. A perfect macroeconomic forecast and the investments associated with that forecast can be ruined by intervention. As such, the portfolio manager must be concerned with contingent states and a probability assessment of those contingencies.

Fiscal authorities and central banks’ intervention have created a form of “government volatility” that may distort risk premiums and artificially drive capital to less-optimal areas. Such actions create yield subsidies crowding out private capital and lead to inefficient capital markets with the risk of unintended consequences

In the emerging markets, for example, an IMF rescue plan can resuscitate a country on the brink of default and instigate a tremendous rally in the bonds. Similarly, in times of conflict, the political decision by a less developed country to allow a developed nation to use its airspace and military bases can provide substantial implicit support to that country’s financial assets. The portfolio manager must consider the abstract unexpected.