The fund industry needs to be better at factoring in political risk when looking at developed markets, according to the research head of Prudential’s investment arm.
Stockpickers struggled to cope with the impact of the political events of last year, as many were unprepared for the market turbulence following the Brexit vote and Donald Trump’s victory in the US election.
But David Shairp, head of research at Prudential Portfolio Management Group, said: “I have found in my experience, that one thing we do not do as an industry is analyse political risk particularly well.”
Yet Mr Shairp, who joined the group from JP Morgan Asset Management back in 2015, admitted there is no systematic process to track political risk, adding often these events can be a one-off that cannot be modelled over history.
“If there is unexplained risk out there, you need to ask whether you’re being paid to take on that potential risk and whether there is enough of a risk premium to justify being exposed to something which you haven’t been able to model.”
“The problem is we do not know for sure how things will pan out,” Mr Shairp said, adding this is why his team has taken a neutral position on UK equities, for example.
“We can model scenarios but ultimately we have to question whether we are compensating to take that exposure.”
Leila Butt, senior economist at PPMG, said the team is “very cognisant” of the risks.
However Ms Butt said: “There will be political fragmentation and possibly rising support for non-mainstream parties but the fact that advanced economies have extremely strong institutions will act to mitigate those risks.”
Pointing to Europe, she said: “Even if non-mainstream parties gain increasing representation, we still expect the established parties to continue to govern.”
Blair Cann, certified financial planner at M Thurlow & Co in Hertfordshire, said it was ridiculous to expect active managers to foresee the results of European Union referendum and the result of US presidential elections.
He said: "They cannot possibly be expected to do that and as far as most other political considerations are concerned they generally can only react to what arises.
"They can only account for political matters if such matters are well signposted and easily predictable whether these are developed markets or undeveloped markets."