Political risk—the idea that political changes can affect the value of investments—used to be a concern primarily related to emerging markets. There are still plenty of political risks emanating from emerging markets, such as Russia’s military adventurism and China’s territorial disputes in the South China Sea. But in recent years developed markets haven’t been spared as political risk has reared its head around the globe.
The latest example of political risk in developed markets comes from the first round of France’s regional elections earlier this week, in which the far-right National Front party garnered the most votes. The National Front’s success is part of a broader trend in Europe where more extreme political parties have gained popularity in countries ranging from the United Kingdom and Denmark to Austria and Hungary. The continent’s refugee crisis and recent terrorist attacks could further increase support for more extreme parties.
There are other possible political changes that could dramatically affect the value of investments as well. In the UK the government has pledged to hold a national referendum on whether the country should remain in the European Union. The US presidential election next year could alter America’s economic and regulatory policies. And any agreements that result from the ongoing UN climate change conference in Paris have the potential upend the energy sector.
Political risk has already left its mark on investments around the world this year. Greece, which was nearly forced to leave the euro zone after the newly-elected Syriza party initially couldn’t agree to a bailout deal with the country’s European creditors, has one of the world’s worst-performing stock markets so far in 2015. Turkey and Egypt, which have become enmeshed in the Middle East’s geopolitical woes, are also among the world’s worst-performing markets.
Yet simply abandoning international investments to try to avoid political risk is a mistake. The stock market in France, despite multiple large-scale terrorist attacks and the surging popularity of the National Front party, has slightly outperformed the US this year. And given how political risk has flared in Europe, it’s possible that the next market-rattling political risk could be in United States. As political risk goes global, having a portfolio that’s well-diversified internationally is a good way to mitigate the impact.