Terrorism risk not fully reflected in markets: Urwin

REIGATE, England — The risk of terrorism has not been fully priced by global markets, said Roger Urwin, global head of investing consulting at Watson Wyatt Worldwide.

The recent foiled terrorism plot in London, the Israel/Hezbollah conflict and the war in Iraq have focused new attention to the link between geopolitical issues and global equity markets, consultants and fund managers said.

"There's increasingly room for smaller groups (of terrorists) to use technological advances to increase bargaining power. This is a new factor in the marketplace," said Mr. Urwin at Watson Wyatt Worldwide in Reigate. "These smaller groups can be more influential in the world now than any other era. As a result, it has become more expensive for more developed nations to defend (national and economic interests) against such difficult-to-locate threats. We've seen this recently in the supply and demand in oil."

Mr. Urwin said downside risks might not be fully priced in global markets, and that's bound to attract more attention as these markets become more correlated.

"As the world moves at some pace toward a greater globalized state, we think it is more important than before to seriously consider macro issues," said Mr. Urwin, who has analyzed the link between variables such as geopolitical risks and equity returns for Watson Wyatt's Thinking Ahead Group.

A clear understanding of how geopolitics drive the global equity markets will allow fund managers "opportunities to exploit longer-term thinking" by establishing exposure in certain asset classes such as commodities ahead of other investors, Mr. Urwin said.

For example, five years ago, many managers would have been uncomfortable investing in oil commodities because of the instability in the Middle East. But for those investors who had understood global economics and politics, "stepping away from the consensus and positioning themselves ahead of the game" could have paid off handsomely, Mr. Urwin said.

Similarly, determining whether this trend has been fully priced into the current market will help investors in the coming years.

Some fund managers are more skeptical about using geopolitics as a key to unlock investment returns.

"Political uncertainty obviously affects (equity) risk premium," said Kenneth Adams, head of global strategy at Scottish Widows Investment Partnership Ltd., Edinburgh, which manages £97.3 billion ($184 billion) in assets as of June 30. "But events such as terrorism are very hard to factor into the risk premium, because any significant event is, if you like, the hardest to forecast. So, how do you forecast such an event with any degree of confidence?"

Furthermore, although such events do affect economic activity, the market has historically proven resilient to such political shocks in the short term, Mr. Adams and other fund managers said.

On Aug. 10, the discovery of a plot to set off explosives aboard planes to the United States from London's Heathrow Airport led to a decline in the FTSE 100, which fell 0.63% to close at 5,823.40 that day. British Airways PLC, Harmondsworth, England, was among the hardest hit as its stock fell 19.75 pence, or 5.06%, to close at 370.25 pence. By Aug. 14, the FTSE 100 had climbed to 5,870.9, the highest level since Aug. 4, and shares in British Airways rose to 377 pence.

However, such events are more difficult to measure in long-term impact, said Ted Scott, London-based manager of F&C Asset Management PLC's Growth & Income fund, which has £53.11 million in assets as of June 30. Overall, F&C manages £107 billion as of June 30.