Availability bias in analysing Political Risk

Investors have just been reminded that there is still plenty of legal price-sensitive information around. The surprises are coming from politics. In theory, markets are meant to be efficient, and intelligently reflect all public information. The rapid arbitrage by the thousands of analysts and investors watching stocks should move prices quickly on news. Yet, behavioural finance highlights one big exception to this. Availability determines how information is used and, indeed, whether it is noticed at all. Information that is prominent, or has been seen recently, is valued more highly. Headlines drive analysis and valuation; we tend to assume that what gets most attention is the most important. Recent share price moves show how wrong that can be.

For weeks FTSE 100 stock, Randgold Resources, was little impacted by the developing political unrest in Mali, where it mines two-thirds of its gold. The turmoil in the country was largely ignored until the March coup instantly triggered a fall of almost 20% in Randgold’s share price. Yet, the risk was entirely overlooked in analyst reports, which seemed to focus more on the short term moves in the gold price. Randgold’s February results were all good news. Indeed, just after this, Randgold’s chief executive told investors that “the continent’s socio-political environment is not the primary risk in building a business in Africa”. Yet, in the same month, but less widely reported, was the news that many thousands had fled Mali as rebellion became evident. When a conjurer encourages us to look the wrong way, we are easily distracted. But analysts should be less easily diverted by companies’ sleight of hand.

Mali may yet return to peace, restoring Randgold’s operations. Yet, what was remarkable was the binary move as analysts switched to sell on the day that fear hit the headlines. Could this be repeated in other countries? Now, we see surprisingly little attention paid to China’s politics. The expulsion of a controversial Politburo member has attracted little press or analytical coverage. Yet, it flashes a warning signal on China’s political reform, pointing to tensions in the pace of change and who benefits from growth. Just because the implications are hard to calculate, does not mean these issues should not be factored in to investment strategy. Analysts should incorporate the risks into discount rates; portfolio managers might diversify more, or retain some cash to invest on weakness.

Availability is one of the big issues of behavioural finance. It lies behind giving too much weight to recent or easily memorable information, and anchoring on remembered share prices. To beat it, analysts need a structured search process, scanning a range of less common news media and inputs, rather than always relying on the usual sources. An attempt should be made to quantify and allow for the unknown. And, sometimes technical weakness can show that a few have been quick to spot some relevant news. This technical position gave a week’s warning with Randgold, as the stock dropped below its moving averages.

Resource stocks seem much more exposed to the type of developments that analysts overlook. Yet, the sector is now a large part of the London market. How good an understanding do investors really have about the political environment in which these operate? Behavioural finance shows investors often underestimate their margin of error. The apparent global nature of Western media creates an illusion of knowledge that gives false comfort. But, the internet allows access to local news from around the world, and can offer greater insight than the headlines that reach the West. Systematic search and factoring-in political risks are key ways in which investors can address psychological failings.