Many investors choose to place a portion of their portfolios in foreign securities. This decision involves an analysis of various mutual funds, exchange traded funds (ETFs), or stock and bond offerings. However, investors often neglect an important first step in the process of international investing. When done properly, the decision to invest overseas begins with determining the riskiness of the investment climate in the country under consideration. Country risk refers to the economic, political and business risks that are unique to a specific country, and that might result in unexpected investment losses. This article will examine the concept of country risk and how it can be analyzed by investors.

Economic and Political Risk
Two main risk sources need be considered when investing in a foreign country:

  • Economic risk: This risk refers to a country's ability to pay back its debts. A country with stable finances and a stronger economy should provide more reliable investments than a country with weaker finances or an unsound economy.
  • Political risk: This risk refers to the political decisions made within a country that might result in an unanticipated loss to investors. While economic risk is often referred to as a country's ability to pay back its debts, political risk is sometimes referred to as the willingness of a country to pay debts or maintain a hospitable climate for outside investment. Even if a country's economy is strong, if the political climate is unfriendly (or becomes unfriendly) to outside investors, the country may not be a good candidate for investment.

Measuring Economic and Political Risk
Just as corporations in the U.S. receive credit ratings to determine their ability to repay their debt, so do countries. In fact, virtually every investable country in the world receives ratings from Moody's, Standard & Poor's (S&P) or the other large rating agencies. A country with a higher credit rating is considered a safer investment than a country with a lower credit rating. Examining the credit ratings of a country is an excellent way to begin analyzing a potential investment.

Another important step in deciding on an investment is to examine a country's economic and financial fundamentals. Different analysts prefer different measures, but almost everyone looks at a country's gross domestic product (GDP), inflation and Consumer Price Index (CPI) readings when considering an investment. Investors will also want to carefully evaluate the structure of the country's financial markets, the availability of attractive investment alternatives and the recent performance of local stock and bond markets.

Sources of Information on Country Risk
There are many excellent sources of information on the economic and political climate of foreign countries. Newspapers, such as the New York Times, The Wall Street Journal and the Financial Times dedicate significant coverage to overseas events. Many excellent weekly magazines also cover international economics and politics; the Economist is generally considered to be the standard bearer among weekly publications.

For those seeking more in-depth coverage of a particular country or region, two excellent sources of objective, comprehensive country information are the Economist Intelligence Unit (EIU) and the Central Intelligence Agency (CIA) "World Factbook." Either of these resources provides an investor with a broad overview of the economic, political, demographic and social climate of a country. The EIU also provides ratings for most of the world's countries. These ratings can supplement those issued by Moody's, S&P and the other "traditional" ratings agencies.

Finally, the internet provides access to a host of information, including international editions of many foreign newspapers and magazines. Reviewing locally produced news sources can sometimes provide a different perspective on the attractiveness of a country under consideration for investment.

Developed, Emerging and Frontier Markets
When considering international investments, there are three types of markets from which to choose:

  • Developed markets consist of the largest, most industrialized economies. Their economic systems are well developed, they are politically stable and the rule of law is well entrenched. Developed markets are usually considered the safest investment destinations, but their economic growth rates often trail those of countries in an earlier development stage. Investment analysis of developed markets usually concentrates on the current economic and market cycles; political considerations are often a less important consideration. Examples of developed markets include the U.S., Canada, France, Japan and Australia.
  • Emerging markets experience rapid industrialization and often demonstrate extremely high levels of economic growth. This strong economic growth can sometimes translate into investment returns that are superior to those available in developed markets. However, emerging markets are also riskier than developed markets; there is often more political uncertainty in emerging markets, and their economies may be more prone to excessive booms and busts. In addition to carefully evaluating an emerging market's economic and financial fundamentals, investors should pay close attention to the country's political climate and the potential for unexpected political developments. Many of the fastest-growing economies in the world, including China, India and Brazil, are considered emerging markets.
  • Frontier markets represent "the next wave" of investment destinations. These markets are generally either smaller than traditional emerging markets, or are found in countries that place restrictions on the ability of foreigners to invest. Although frontier markets can be exceptionally risky and often suffer from low liquidity, they also offer the potential for above-average returns over time. Frontier markets are also not well correlated with other more traditional investment destinations, which means that they provide additional diversification benefits when held in a well-rounded investment portfolio. As with emerging markets, investors in frontier markets must pay careful attention to the political environment, as well as to economic and financial developments. Examples of frontier markets include Nigeria, Botswana and Kuwait.

Important Steps When Investing Overseas
Once country analysis has been completed, several investment decisions need to be made. The first choice is to decide where to invest, by choosing among several possible investment approaches, including:

  • Investing in a broad international portfolio
  • Investing in a more limited portfolio focused on either emerging markets or developed markets
  • Investing in a specific region, such as Europe or Latin America
  • Investing only in a specific country(s)

Remember that diversification, a fundamental principle of domestic investing, is even more important when investing internationally. Choosing to invest an entire portfolio in a single country is not prudent. In a broadly diversified global portfolio, investments should be allocated among developed, emerging and perhaps frontier markets. Even in a more concentrated portfolio, investments should be spread among several countries to maximize diversification and minimize risk.

After deciding where to invest, an investor must decide which investment vehicles to invest in. Investment options include sovereign debt, stocks or bonds of companies domiciled in the country(s) chosen, stocks or bonds of a U.S.-based company that derives a significant portion of its revenues from the country(s) selected, or an internationally focused ETF or mutual fund. The choice of investment vehicle depends on each investor's individual knowledge, experience, risk profile and return objectives. When in doubt, it may make sense to start out by taking less risk; more risk can always be added to the portfolio later.

In addition to thoroughly researching prospective investments, an international investor also needs to monitor his or her portfolio and adjust holdings as conditions dictate. As in the U.S., economic conditions overseas are constantly evolving, and political situations abroad can change quickly, particularly in emerging or frontier markets. Situations that once seemed promising may no longer be so, and countries that once seemed too risky might now be viable investment candidates.

Overseas investing involves a careful analysis of the economic, political and business risks that might result in unexpected investment losses. This country risk analysis is a fundamental step in building and monitoring an international portfolio. Investors that use the many excellent information sources available to evaluate country risk will be better prepared when constructing their international portfolios.

Related Articles
  1. Mutual Funds & ETFs

    ETF Analysis: iShares MSCI United Kingdom

    Understand how the iShares MSCI United Kingdom exchange-traded fund is managed, how it tracks its benchmark and for whom it is most suitable.
  2. Mutual Funds & ETFs

    Top 3 Vanguard Managed ETFs

    Find out which three Vanguard exchange-traded funds made into the list of best Vanguard products for new and established ETF investors.
  3. Economics

    3 Ways You Can Evaluate Country Risk

    Diversifying your portfolio includes looking beyond your borders. Here are a few ways to analyze risk when investing abroad.
  4. Mutual Funds & ETFs

    Getting Into International Investing

    Diversifying can mean not only investing in various asset classes but also venturing beyond domestic exchanges.
  5. Forex Education

    The 3 Biggest Risks Faced By International Investors

    Investing internationally is a great way to diversify your portfolio, but you need to know the risks.
  6. Economics

    Cautionary Signs For International Investors

    "Going global" is a fashionable investing style, but investors should know the risks.
  7. Economics

    Forging Frontier Markets

    Pioneering is never easy, but it has its exciting - and worthwhile - moments for investors.
  8. Economics

    Long-Term Investing Impact of the Paris Attacks

    We share some insights on how the recent terrorist attacks in Paris could impact the economy and markets going forward.
  9. Chart Advisor

    Copper Continues Its Descent

    Copper prices have been under pressure lately and based on these charts it doesn't seem that it will reverse any time soon.
  10. Trading Strategies

    How to Trade In a Flat Market

    Reduce position size by 50% to 75% in a flat market.
  1. How does the risk of investing in the metals and mining sector compare to the broader ...

    The metals and mining sector faces specific investment risks, such as highly capital intensive projects, regulatory changes, ... Read Full Answer >>
  2. Is Malaysia a developed country?

    Despite undergoing rapid economic development over the past five decades, Malaysia is not considered a developed country, ... Read Full Answer >>
  3. How do mutual funds work in India?

    Mutual funds in India work in much the same way as mutual funds in the United States. Like their American counterparts, Indian ... Read Full Answer >>
  4. Is Mexico an emerging market economy?

    Mexico meets all the criteria of an emerging market economy. The country's gross domestic product, or GDP, per capita beats ... Read Full Answer >>
  5. Why should an investor include an allocation to the telecommunications sector in ...

    An investor should include an allocation to the telecommunications sector in his portfolio, because telecom offers an investor ... Read Full Answer >>
  6. What portion of the telecommunications sector will benefit most from continued growth ...

    The portion of the telecommunications sector that is projected to benefit most from the continued growth in the use of cellphones ... Read Full Answer >>

You May Also Like

Hot Definitions
  1. Take A Bath

    A slang term referring to the situation of an investor who has experienced a large loss from an investment or speculative ...
  2. Black Friday

    1. A day of stock market catastrophe. Originally, September 24, 1869, was deemed Black Friday. The crash was sparked by gold ...
  3. Turkey

    Slang for an investment that yields disappointing results or turns out worse than expected. Failed business deals, securities ...
  4. Barefoot Pilgrim

    A slang term for an unsophisticated investor who loses all of his or her wealth by trading equities in the stock market. ...
  5. Quick Ratio

    The quick ratio is an indicator of a company’s short-term liquidity. The quick ratio measures a company’s ability to meet ...
  6. Black Tuesday

    October 29, 1929, when the DJIA fell 12% - one of the largest one-day drops in stock market history. More than 16 million ...
Trading Center