Where In The World Is Risk Today?

by: Russ Koesterich, CFA

With the sovereign debt crisis centered in the developed world, the traditional notion that all developed markets are less risky for investors than all emerging markets doesn't hold up anymore. Today, while developed markets certainly top the list of the least risky countries and vice versa for emerging markets, some developed markets are now just as risky as emerging markets. At the same time, some emerging countries are now just as safe as their developed market counterparts.

It's no wonder, then, that determining how various developed and emerging markets currently stack up in terms of riskiness can be tough, especially given today's highly volatile markets. Figuring out the riskiness of a country, however, is very important for investors. In "risk-off" environments, the valuations of high risk countries tend to suffer more than the valuations of lower risk countries. Similarly, valuations of higher risk countries tend to benefit more in "risk-on" environments.

David Wang, a researcher on my Investment Strategy Group team, recently performed an analysis that can help investors determine where in the world risk is today. Using a combination of countries' macroeconomic characteristics and one-year market index volatility, David developed a ranking of countries' riskiness.

Here's his list of the top 15 riskiest countries today, i.e. the countries whose valuations are most sensitive to "risk-on" and "risk-off" sentiment shifts:

1) Hungary

2) Italy

3) Austria

4) Sweden

5) Poland

6) Finland

7) Spain

8) Germany

9) France

10) Russia

11) Norway

12) South Korea

13) Turkey

14) Netherlands

15) Brazil

So how did David come up with his ranking? He started with four hypotheses:

  1. Countries exposed to the European sovereign debt crisis should be classified as higher risk.
  2. Developed market countries with stable currencies during volatile periods should be classified as lower risk.
  3. Emerging market countries with more cyclical sector exposure may be higher risk.
  4. Emerging market countries with better fiscal and growth situations should be classified as lower risk.

He used these hypotheses to come up with a rough ranking of countries' riskiness and then confirmed that list with one-year volatility measures of country MSCI indices.

To be sure, a country's riskiness can shift over time with changing economic conditions. For instance, if the European sovereign debt crisis were solved tomorrow, the risk ranking above would certainly change. But for now, the country risk ranking above can potentially help investors adapt their portfolios to today's macroeconomic landscape.

Source: iShares Investment Strategy Group research

Disclosure: No positions

Disclaimer: In addition to the normal risks associated with investing, international investments may involve risk of capital loss from unfavorable fluctuation in currency values, from differences in generally accepted accounting principles or from economic or political instability in other nations. Emerging markets involve heightened risks related to the same factors as well as increased volatility and lower trading volume. Securities focusing on a single country may be subject to higher volatility.

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