Where in the World is Risk Today?

by Russ Koes­terich, Chief Invest­ment Strate­gist, iShares

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