Risk assessment

One reads a lot about how cheap the Russian stock market is, in theory trading on less than 5x its forecast earnings. Certainly in a developed economy that would be considered ridiculously cheap. We are often asked about the investment case for emerging markets. Emerging market investing comes with risks that are hard to quantify, the first being political; Russia currently being an example. Secondly, currency risk, emerging markets currency can be volatile and any profits made in the underlying investment can be lost in the currency. Regulatory and accountancy rules may be different, the company may look cheap, but are you 100% sure the investment case stacks up. Corporate Governance may not be as robust in emerging market investments as it is in more developed economies. One needs to take all these considerations on board. 

What an investor can do is invest in companies that invest in emerging markets. One does not get the gearing one might from a direct investment in an emerging market but what one does get is a level of comfort with the investment and insulates oneself from some of the risks above. 

Investment is about risk and reward, how much reward do you expect for the risk you take. Professional investors get it wrong, but they do generally try and evaluate the reward they are receiving for the risk they are taking and are therefore possibly better able to deal with the volatility.

It does not need a psychologist to see by human behaviour how events shape people's attitude to risk. One would bet after the tragic accident to Michael Schumacher the sales of skiing helmets rose. The likelihood of a person having a skiing accident is the same before as it was after Michael Schumacher's accident, but peoples perceived risk will be higher. The risks of investing in Russian equities is probably about the same today as it was a year ago, people's perception of the risk is that it is now higher, hence the cheaper valuation. The question should be: were investors underpricing the risk a year ago or are they overpricing it today?

People’s attitude to risk differs, but one should always be aware that a disproportionate return to the average probably means that the risk is greater. Ask the people who owned Isave accounts. The Interest they were receiving was superior to the return they could receive in a domestic high street bank, when they decided to open an Isave account they were not aware of the risks or decided the risks were worth taking for the increased return. 

For those who are tempted by investing in the Russian market one has to remember you are buying exposure to the oil and gas industry mainly. For those who are slightly less risk averse but feel the last few week's events have created opportunities, you may not have to look as far as the Russian border.

Posted on March 28, 2014 .