In this sense, Ian Bremmer and Preston Keat’s The Fat Tail: The Power of Political Knowledge for Strategic Investing is long overdue. The authors, both at the prestigious consulting firm Eurasia Group, draw on years of top-level advisory experience to provide the first accessible and rigorous treatment of political risk for business executives. “Fat tail” is a statistical term that refers to a bump at the end of a distribution curve where there is added risk, but the likelihood that a particular event will occur “appears so catastrophically damaging, unlikely to happen, and difficult to predict, that many of us choose to simply ignore it. Until it happens.” The authors’ main point: Black swans, as Nassim Nicholas Taleb calls them, can be political as well as financial.
Such is the volume’s tone as it takes the reader through a wide variety of events that wreaked havoc in capital markets, including the Russian ruble devaluation of 1998, the 2003 PDVSA oil strikes in Venezuela, the 9/11 terrorist attacks, and the passage of the U.S. Sarbanes-Oxley legislation in 2002. Indeed, as shown by the critical firestorm that forced state-owned China National Offshore Oil Company to withdraw its bid to acquire Unocal in the U.S. in 2005, local political sensitivities impact investments everywhere, even in the United States.
Bremmer and Keat turn the amorphous notion of risk into a catalog of former secretary of defense Donald Rumsfeld’s oft-quoted “known unknowns” and “unknown unknowns,” covering warfare, energy supply disruptions, terrorist attacks, coups and civil wars, expropriation and breaches of contract, currency controls and defaults, global warming and demographics, and, of course, corruption. Along the way they offer sensible resilience mechanisms to prepare for such events (e.g., risk mapping, data collection, scenario analysis), ensure continued operations (e.g., personnel location), and hedge strategic bets (e.g., joint ventures).
But lest we begin to believe that political risk is fully manageable, Robert P. Smith’s Riches among the Ruins: Adventures in the Dark Corners of the Global Economy (written with Peter Zheutlin) provides a stark reminder that “frontier markets” can be a euphemism for the chaotic Third World. Smith, the founder and managing director of the Turan Corporation, which specializes in emerging-market sovereign debt, takes us on a tour of places where he says you have to “hold on to your wallet and your life”: El Salvador, Guatemala, Iraq, Nigeria, Russia, Turkey, and Vietnam.
In the 1970s and ’80s, before dollarization and Bloomberg terminals, sovereign debt–trading middlemen like Smith relied on chutzpah and instinct to determine bond prices and find trusted money changers. For such financial swashbucklers, understanding people was as important as, if not more important than, understanding markets. Clearly, improvisation was Smith’s greatest gift: He carried large volumes of cash internationally, set up local holding companies to collect debts, and sent alias-named proxy lawyers to scout for contacts and information — anything to get the job done.
Even as the sovereign debt trade has grown into a $1.7 trillion industry conducted by multinational banks and investment firms, Smith’s characters are alive and well today, just dressed better and using BlackBerrys instead of rotary-dial telephones. After reading this book, one wonders how Arab and Chinese investors described by Simpfendorfer will treat the frontier markets of Uzbekistan, Afghanistan, and Pakistan that lie between them on the New Silk Road.
Smith witnessed every incident in The Fat Tail taxonomy, from arbitrary currency controls to coups to expropriations. His implicit reminder is that emerging markets are a long-term investment. It’s a reminder that would have been worth hearing in late 2008, when the worldwide flight of capital to safety caused foreign direct investment in the developing world to plummet. Many analysts threw the baby out with the bathwater, and the U.S. became the default market of choice even at near zero percent yield on Treasury securities. But, in fact, by April 2009, the Wall Street Journal was already reporting a surge in emerging market indexes. Growth had not gone negative, and foreign exchange reserves and high savings rates combined to restore stability.