Geo-Political Risks and Your Portfolio

Includes: AFK, GMF, GUR, ILF
by: Efficient Alpha

The Intelligent Insurer has released its Global Political Risk map for 2011, which is available for download. The map color codes each country based on a quantified risk to stability. The rating scale includes five levels and ranges from low to severe. The map includes icons for industries at risk (oil & gas, power, pulp & paper, or mineral extraction), and three icons for corruption, political violence, or exchange convertability risk. Noted are Standard and Poor’s rating for each country, foreign direct investment flows in the top emerging nations, and emerging market election dates. While the ratings themselves seem to be on the overly cautionary side - only three countries get the low risk rating and the U.S. is labeled with caution - the relative ratings provide a good measure of comparative risk between countries. The site itself does not provide commentary. Below are some issues that I have been following and funds that provide exposure to the region.

Much of east Africa is experiencing an historic drought ranging across Somalia to northern Kenya and as far west as Sudan. The increased food insecurity is causing escalations in an already tense region. Global food prices remain an area of possible flash point across the globe, especially in regions in which a larger proportion of income is spent on subsistence. The UN Food and Agriculture Organization (FAO) reported in May that its food-price index rose 39% on a year-over-year basis. Though extreme weather conditions in Russia and Australia had a sizeable effect on wheat prices and should prove temporary, global supply and demand issues will remain. The Market Vectors Africa Index ETF (AFK) replicates the Dow Jones Africa Titans 50 IndexSM. The fund has a one-year total return of 18.6% but only trades an average of 20k shares daily.

The U.S. imposed sanctions against Venezuela’s state-owned oil company, Petroleos de Venezuela (PDVSA) in May under the U.S. Iran Sanctions Act, including prohibiting the company from entering into contracts with the U.S. government, loans from the U.S. Import-Export Bank, and other patent restrictions. The sanctions will not affect the flow of oil from the South American country to the U.S. or its subsidiary, CITGO.

The government of Ecuador declared the U.S. Ambassador Hodges to be persona non grata in April, as WikiLeaks reported cables from Hodges critical of the Correa government and systemic corruption in the country. Relations remain tense, though Ecuador is still considered one of the more U.S.-friendly countries among South America’s leftist regimes. Though the fund is only exposed to the equities of four countries in the region (Mexico, Brazil, Argentina, and Chile) the iShares S&P Latin America 40 Fund (ILF) has returned 77% over the last five years versus a loss of 8.6% for the S&P500 (NYSEARCA:SPY) during the same period.

Despite an agreement last week to stabilize the sovereign debt crisis in Europe, issues promise to flair up again. The relative health of the Italian economy should keep it from the problems facing Greece, Ireland, Portugal, and Spain. Ten-year government bond yields have come down somewhat with Greek, Spanish, Italian, and German yields of 14.7%, 5.8%, 5.3%, and 2.9% respectively. The meeting last week agreed to fund another €109 billion to help Greece meet its debt payments over the next few years. The group also agreed to reduce the interest rate charged on Greek borrowing from the EU to 3.5% from 5% and pushed the repayment terms out to 15 years from seven. Ireland and Portugal will be given lower rates on their borrowings as well. The fund used by the Union, the European Financial Stability Facility, has been expanded to €440 billion and has been given the power to provide loans without an official green-light from the EU or IMF.

Elections in Russia this winter may increase political tension in the country as the Popular Front and the Nationalist Front vie for control. Parliamentary elections occur in December and a new president is elected next March. Medvedev has given us a rather uneventful period, but with Putin’s approval ratings still as high as 53 percent, the chances are good for reelection. The SPDR S&P Emerging Europe ETF (GUR) provides substantial exposure to Russia. Investors should look closely at the rest of their portfolio for sector weightings as the fund has 77.2% of its weight in energy, financial services, and basic materials.

Turkey’s June parliamentary elections strengthened Prime Minister Erdogan’s Justice & Development Party (AKP). Turkey has become a regional player despite repeated failed attempts to join the EU. Rising tensions in neighboring Syria have caused an influx of more than 10,000 refugees and threaten the recent political stability, though the country has been largely immune to this year’s Arab Spring.

U.S. Admiral Mullen visited China last week in continued moves by Washington to build military relations with the world’s second largest economy. The move comes as China is locked in a series of heated exchanges with neighbors over access and rights to the South China Sea. The 1.3 million square mile area includes some of the world’s busiest shipping lanes and recently is believed to hold large deposits of oil and natural gas. More than half a dozen regional powers compete for territorial claims including Vietnam, Taiwan, the Philippines, Malaysia, Brunei, and China. The SPDR S&P Emerging Asia Pacific ETF (GMF) provides good exposure to the region but is significantly overweight financial services and technology with 48.2% of the portfolio equally divided between the two. The fund presents an attractive average price-to-earnings ratio of 12.8 times.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.