Geopolitical risk is the risk associated with tensions or actions between actors (state and non-state) that affect the normal and peaceful course of international relations. Geopolitical risk tends to rise when the geographic and political factors underpinning country relations shift.

There are three basic types of geopolitical risk.

• Event risk evolves around set dates known in advance. Political events, for example, often result in changes to investors expectations related to a country's cooperative stance.

• Exogenous risk is a sudden or unanticipated risk that can impact either a country's cooperative stance, the ability of non-state actors to globalize, or both. Unexpected revolutions, invasions, or the aftermath of natural calamities are a few examples.

• Thematic risks are known risks that evolve and expand over a period of time. Examples include the persistent danger of terrorism, climate change, migratory patterns, the emergence of populist movements, and cyber threats.

To make an assessment, an investor considers geopolitical risk in terms of the following three areas:

• The likelihood it will occur considers the probability that geopolitical risk will occur.

• The velocity (speed) of its impact is the pace at which it impacts an investor's portfolio.

• The impact can manifest in many ways and can be discrete in size and broad in nature.

Investors should consider all three geopolitical risk factors when evaluating geopolitical risk for portfolio management. For instance, a risk that is extremely probable but has minimal effect on the portfolio may not warrant in-depth research and investor attention.

Geopolitical risks seldom develop in linear fashion, making it difficult to monitor and forecast their likelihood, velocity, and size and nature of impact on a portfolio. As a result, many investors deploy an approach that includes scenario building and signposting rather than a single point forecast.

Scenario analysis is the process of evaluating portfolio outcomes across potential circumstances or state of the world. Scenario analysis might be a qualitative analysis, quantitative measurement, or a combination of the two.

Asset managers create procedures in preparation that provide quick corrections in order to strengthen a portfolio's resistance to unforeseen change. The process of detecting warning signs for proper risk management is crucial. A signpost is an indicator, data piece, or event suggesting that risk increases or decreases in likelihood. The ability to recognize signposts should enable a team to distinguish between signal and noise and respond when signposts indicate increased risk.

Acting on Geopolitical Risk

Assessing a risk's likelihood, velocity, and impact might assist an investor in choosing which risks may be the most significant. They may impact key capital market assumptions.

Investors might consider geopolitical risk in multi-factor models at the portfolio management level.

Investing objectives, risk tolerance, and time horizon all affect how important geopolitical risk is to the process.