Three ways to assess your portfolio’s exposure to autocratic regimes

Over the past decade a global decline in democracy has increased investor exposure to autocratic regimes. Here’s how to weigh up the direct and indirect risks to your portfolio across index funds, active funds and hedge funds. 

Russia’s invasion of Ukraine and the subsequent crash in its stock market and currency have exposed the risks private individuals face when investing in autocratic regimes. The ensuing economic sanctions imposed by many countries, including moves to block some Russian banks from the SWIFT international payment system and to restrict Russia’s use of its massive foreign currency reserves, revealed broader systemic risks associated with investing in assets affiliated with such regimes.

With democracy having lost ground over the past decade, the geopolitical risk for investors is mounting. According to the 2022 survey of the Bertelsmann Transformation Index, 70  out of 137 countries were classified as autocracies, compared with just 67 democracies.

What does this mean for private investors and how can they ensure they are properly mitigating against geopolitical risk?

We recommend that high net-worth individuals, family offices, and their financial intermediaries regularly assess their portfolios’ possible exposure to such systemic geopolitical risks, and make deliberate decisions to accept or mitigate by following this three-step guide:

1. Develop a classification system or dashboard for countries

An autocracy is a system of government in which absolute power of a state is concentrated in the hands of one person. Among the features of autocratic regimes are a lack of public and political data transparency; weak governance structures, judicial systems and shareholder rights; controlled elections and extensive corruption; human rights violations; and the concentration of personal wealth in the hands of a few. 

To try to gauge where a country stands on the autocratic scale, we suggest developing a classification system to rank its type of government.  The World Economic Forum’s Global Competitiveness Index, IMD’s World Competitiveness Rankings, Transparency International’s Global Corruption Index, Cato Institute’s Human Freedom Index, and the Heritage Foundation Economic Freedom Index are all reliable sources that use a variety of metrics , such as judicial effectiveness, government integrity and financial freedom, to identify countries as autocracies.

As mentioned above, 70 countries in the Bertelsmann Transformation Index are considered autocracies: six of these are in Latin America, 46 in Africa and the Middle East, seven in post-Soviet Eurasia, and 11 in Asia. A worrisome 2021 Freedom House report reveals that anti-democratic practices have spread across Central Europe and Central Asia, with 18 out of 29 countries suffering declines in their democracy scores. In particular, Russia, Azerbaijan, Belarus, Tajikistan, Turkmenistan and Uzbekistan have the lowest profiles. 

Investors would also benefit from consulting services such as BlackRock’s Geopolitical Risk dashboard that scores specific geopolitical risks, including what it calls the “Russia-NATO conflict”.