Political Risk and Investors

Around the Curve

Political Risk and Investors

How can investors analyze – and quantify – the levels of political risk for fixed income?

Executive Summary

  • In the first of this two-part series, we outline how political risk is priced into sovereign bond yields and how long that risk premium could last.
  • We then review a few typical indicators to determine whether they serve a dual purpose for economic and political analyses.
  • Ultimately, we suggest evaluating economic data in conjunction with more qualitative factors such as income inequality and governance to identify significant shifts in political sentiment that may yield policy implications.


As global bond investors, analyzing economic indicators is like second nature to us. However, political risk has become a prevalent factor in both local- and hard-currency sovereign bond valuations over the last several years. Since we already evaluate price and information risk, there could be merit in reviewing traditionally quantitative factors through a qualitative lens, at least when it comes to political risk. We’ve read some compelling research about the effect political risk has on asset prices. For instance, Capital Economics evaluated the amount of risk premia priced into spreads following a political shock and how long that particular risk remains priced into a country’s sovereign bonds.

Similarly, J.P. Morgan outlined that it typically takes bond and equity markets about three months to retrace their losses following a geopolitical shock. Reviewing historical data is certainly helpful when trying to understand the financial and economic impact of politics, but is there a way for investors to contemporaneously evaluate risk factors to better understand—or even prepare for—these watershed events? We think there are certain economic indicators that investors can also evaluate within the context of politics, so these events become less of a shock and more of an opportunity to make tactical decisions.

Populism Poses the Biggest Political Risk

It used to be the case that major geopolitical events occurred about twice a decade; however, that changed after the 2016 U.S. presidential election. Since then, significant geopolitical events have materialized more frequently. These types of events have become more commonplace as a result of the global shift toward populism—a form of political risk that has the highest and stickiest risk premia according to Capital Economics. Chart 1 illustrates how the market provides an excess 20 basis points for political risk in dollar-denominated sovereign bonds, and the trailing effects of political events, which could last anywhere from one day to about six months.

Sources: Refinitiv, Capital Economics.  Past performance is no guarantee of future results. This information is provided for illustrative purposes only and does not reflect the performance of an actual investment.


Markets appear to provide excess spreads for bearing political risk—a topic we previously covered in a blog about Environmental, Social, and Governance factors. However, the risks associated with a rise in populism appear to persist for about six months or longer; an astute political analyst could potentially capture the excess spread over time and also capitalize on significant price appreciation should the risk be analyzed correctly.

Since populism is a global phenomenon, let’s review economic data in conjunction with sentiment factors in emerging market countries like Brazil, India, Mexico, and South Africa to see whether their election results match up with external and internal conditions.

Economic Indicators

A country’s external balances play a paramount role in our macro analysis and exogenous factors like the implementation of developed market unorthodox monetary policies in response to the Global Financial Crisis (GFC) have challenged emerging market economies. The impact of external events on these particular economies has been large given their varying stages of development, institutional structures, and generally more challenged aggregate balance sheets and current account balances. Markets are already quick to price in these weaker economic profiles, yet these weaknesses have manifested themselves in greater political risk. How beholden are emerging market economies to external influences? Let’s first review some typical external liabilities for South Africa, India, Brazil, and Mexico over the post-GFC period. Then, we can begin to understand political risk within the context of the economic backdrop.

Foreign Direct Investment (FDI) Flows

We’ve always been particularly interested in whether domestic policymaking can attract foreign capital. Chart 2 below shows FDI flows for the four countries of interest:


Source: Haver Analytics. Past performance is no guarantee of future results. This information is provided for illustrative purposes only and does not reflect the performance of an actual investment.


We can then align these flows with the political undercurrent within these countries. Foreign capital fled South Africa at the end of 2018 as business confidence remained suppressed and market sentiment turned increasingly skeptical regarding President Cyril Ramaphosa’s ability to implement reform. Similarly, FDI into Mexico declined as the Andrés Manuel Lez Obrador (AMLO) Administration began to limit foreign participation in the country’s energy auctions. Conversely, FDI began to flood Brazil around the time that President Jair Bolsonaro was inaugurated. The curious case here is India, which has been notoriously skeptical of foreign investment. After all, this was a closed economy up until the 1990s.

GDP Growth

When Prime Minister Narendra Modi was elected in 2014—upending the political establishment—he also sought to further liberalize India’s notoriously nationalist economy. Yet, FDI has continued to hover around 2% of GDP as shown in Chart 2 above. While investors would expect a steady increase in FDI under the Modi Administration, does the populace really care about the level of foreign investment? India, along with the other three countries we’re evaluating, have seen their overall balance of payments improve as their current account deficits shrink. To varying degrees, foreign investment has been used to finance their current account deficits, which have improved over time as illustrated in Chart 3 below:


Source: Haver Analytics. See notes for definitions of terms. Past performance is no guarantee of future results. This information is provided for illustrative purposes only and does not reflect the performance of an actual investment.


While current account deficits matter to investors, do average voters even care about balances of payments or attracting foreign capital? What likely resonates more with the population—particularly during an election cycle—are less abstract principles, like economic growth. Chart 4 outlines historic GDP levels:


Source: World Bank. Past performance is no guarantee of future results. This information is provided for illustrative purposes only and does not reflect the performance of an actual investment.


When overlaying GDP growth with key political events, we can make some deductions. For example, let’s track Brazilian GDP, which began to contract in 2010 as the term ended for the country’s immensely popular former president—Luiz Inácio “Lula” da Silva. His successors, Dilma Rousseff and Michel Temer, were mired in scandals as the economy fell into recession. This example highlights why it’s important to look at political and economic conditions together. In Brazil, the simultaneous decline in economic growth and effective governance may have precipitated a profound ideological shift within the population. Therefore, it makes sense that voters rejected the Workers’ Party in favor of a fringe candidate like Bolsonaro.

However, GDP doesn’t neatly explain AMLO’s victory in Mexico, Modi’s ascendancy in India, or Ramaphosa’s nomination and recent reelection in South Africa. Sure, Mexican and South African GDP growth tapered off over time—South Africa even fell into technical recession; however, Indian GDP growth modestly improved during former prime minister Manmohan Singh’s second term. Yet Modi and the Bharatiya Janata Party (BJP) swept the 2014 elections.

Part Two: The Role of the Consumer

In the next article, we’ll highlight the role of the consumer in changing the composition of GDP growth within these economies and how factors like income inequality and perceptions of corruption present another facet in evaluating indicators like unemployment and wage growth.


For bonds, risk premium refers to the extra yield investors require to invest in bonds issued by non-government entities.

One basis point (bps) equals one one-hundredth of one percentage point.

A current account balance summarizes the flow of goods, services, income and transfer payments into and out of a country.

Gross Domestic Product ("GDP") is an economic statistic which measures the market value of all final goods and services produced within a country in a given period of time.


Important Information


All investments involve risk, including possible loss of principal.

The value of investments and the income from them can go down as well as up and investors may not get back the amounts originally invested, and can be affected by changes in interest rates, in exchange rates, general market conditions, political, social and economic developments and other variable factors. Investment involves risks including but not limited to, possible delays in payments and loss of income or capital. Neither Legg Mason nor any of its affiliates guarantees any rate of return or the return of capital invested. 

Equity securities are subject to price fluctuation and possible loss of principal. Fixed-income securities involve interest rate, credit, inflation and reinvestment risks; and possible loss of principal. As interest rates rise, the value of fixed income securities falls.

International investments are subject to special risks including currency fluctuations, social, economic and political uncertainties, which could increase volatility. These risks are magnified in emerging markets.

Commodities and currencies contain heightened risk that include market, political, regulatory, and natural conditions and may not be suitable for all investors.

Past performance is no guarantee of future results.  Please note that an investor cannot invest directly in an index. Unmanaged index returns do not reflect any fees, expenses or sales charges.

The opinions and views expressed herein are not intended to be relied upon as a prediction or forecast of actual future events or performance, guarantee of future results, recommendations or advice.  Statements made in this material are not intended as buy or sell recommendations of any securities. Forward-looking statements are subject to uncertainties that could cause actual developments and results to differ materially from the expectations expressed. This information has been prepared from sources believed reliable but the accuracy and completeness of the information cannot be guaranteed. Information and opinions expressed by either Legg Mason or its affiliates are current as at the date indicated, are subject to change without notice, and do not take into account the particular investment objectives, financial situation or needs of individual investors.

The information in this material is confidential and proprietary and may not be used other than by the intended user. Neither Legg Mason or its affiliates or any of their officer or employee of Legg Mason accepts any liability whatsoever for any loss arising from any use of this material or its contents. This material may not be reproduced, distributed or published without prior written permission from Legg Mason. Distribution of this material may be restricted in certain jurisdictions. Any persons coming into possession of this material should seek advice for details of, and observe such restrictions (if any).

This material may have been prepared by an advisor or entity affiliated with an entity mentioned below through common control and ownership by Legg Mason, Inc.  Unless otherwise noted the “$” (dollar sign) represents U.S. Dollars.

This material is approved for distribution in those countries and to those recipients listed below. Note: this material may not be available in all regions listed.

All investors and eligible counterparties in Europe, the UK, Switzerland:

In Europe (excluding UK and Switzerland), this financial promotion is issued by Legg Mason Investments (Ireland) Limited, registered office 6th Floor, Building Three, Number One Ballsbridge, 126 Pembroke Road, Ballsbridge, Dublin 4, D04 EP27. Registered in Ireland, Company No. 271887. Authorised and regulated by the Central Bank of Ireland.

All Qualified Investors in Switzerland:
In Switzerland, this financial promotion is issued by Legg Mason Investments (Switzerland) GmbH. Investors in Switzerland: The representative in Switzerland is FIRST INDEPENDENT FUND SERVICES LTD., Klausstrasse 33, 8008 Zurich, Switzerland and the paying agent in Switzerland is NPB Neue Privat Bank AG, Limmatquai 1, 8024 Zurich, Switzerland. Copies of the Articles of Association, the Prospectus, the Key Investor Information documents and the annual and semi-annual reports of the Company may be obtained free of charge from the representative in Switzerland.

All investors in the UK:
In the UK this financial promotion is issued by Legg Mason Investments (Europe) Limited, registered office 201 Bishopsgate, London EC2M 3AB. Registered in England and Wales, Company No. 1732037. Authorized and regulated by the Financial Conduct Authority. Client Services +44 (0)207 070 7444

All Investors in Hong Kong and Singapore:

This material is provided by Legg Mason Asset Management Hong Kong Limited in Hong Kong and Legg Mason Asset Management Singapore Pte. Limited (Registration Number (UEN): 200007942R) in Singapore.

This material has not been reviewed by any regulatory authority in Hong Kong or Singapore.

All Investors in the People's Republic of China ("PRC"):

This material is provided by Legg Mason Asset Management Hong Kong Limited to intended recipients in the PRC.  The content of this document is only for Press or the PRC investors investing in the QDII Product offered by PRC's commercial bank in accordance with the regulation of China Banking Regulatory Commission.  Investors should read the offering document prior to any subscription.  Please seek advice from PRC's commercial banks and/or other professional advisors, if necessary. Please note that Legg Mason and its affiliates are the Managers of the offshore funds invested by QDII Products only.  Legg Mason and its affiliates are not authorized by any regulatory authority to conduct business or investment activities in China.

This material has not been reviewed by any regulatory authority in the PRC.

Distributors and existing investors in Korea and Distributors in Taiwan:

This material is provided by Legg Mason Asset Management Hong Kong Limited to eligible recipients in Korea and by Legg Mason Investments (Taiwan) Limited (Registration Number: (109) Jin Guan Tou Gu Xin Zi Di 016; Address: Suite E, 55F, Taipei 101 Tower, 7, Xin Yi Road, Section 5, Taipei 110, Taiwan, R.O.C.; Tel: (886) 2-8722 1666) in Taiwan. Legg Mason Investments (Taiwan) Limited operates and manages its business independently.

This material has not been reviewed by any regulatory authority in Korea or Taiwan.

All Investors in the Americas:

This material is provided by Legg Mason Investor Services LLC, a U.S. registered Broker-Dealer, which includes Legg Mason Americas International. Legg Mason Investor Services, LLC, Member FINRA/SIPC.

All Investors in Australia and New Zealand:

This document is issued by Legg Mason Asset Management Australia Limited (ABN 76 004 835 839, AFSL 204827).  The information in this document is of a general nature only and is not intended to be, and is not, a complete or definitive statement of matters described in it. It has not been prepared to take into account the investment objectives, financial objectives or particular needs of any particular person.

Forecasts are inherently limited and should not be relied upon as indicators of actual or future performance.

The aforementioned Legg Mason entities are wholly owned subsidiaries of Franklin Resources, Inc.

Yields and dividends represent past performance and there is no guarantee they will continue to be paid.

Forecasts are inherently limited and should not be relied upon as indicators of actual or future performance.