Stories of storms, droughts and other local extremes bring about all kinds of varied reactions: relief aid, renewed political will to solve problems of poverty and environmental degradation, and, inevitably, jittery investors.
Mexico in the last 18 months has been the case study for country-specific risk: An escalation in the drug war coincided with the global economic downturn, and was quickly followed by the swine flu outbreak. (It didn't seem to matter that the drug war and the flu outbreak affected only parts of the country.) To this, one cal also add a severe drought. Sure enough, travel slowed to a trickle and investors who weren't already exposed in Mexico stayed on the sidelines.
For international investors, these are some of the factors that can make a country more or less attractive for investment. Given that not all investing environments are as transparent, mature, and stable as the United States, single-country international projects or companies can therefore be riskier investments. So these factors necessarily affect the valuation of an international investment.
In public equity investing, these country-specific risk factors usually are denoted with a proxy measure, such as the default risk of the country’s central bank. The political environment, economic conditions, business institutions and property laws, and the country's fiscal health are thought to be reflected in this measure, giving investors a pretty good macro look at their country-specific risk.
The small, speculative nature of most ecotourism projects makes foreign investments even more risky. First, small projects are inherently more risky for an investor, because of exposure to local extreme events, fewer securable assets and related disadvantages of small-scale operations.
Each of these projects also brings its own idiosyncratic, project-specific risks that include getting permits, maintaining enforcement of property rights, and avoiding the costs of corruption. Many of these local factors, in turn, are dependent upon national-level institutions that protect physical and intellectual property, and protect against things like corruption.
In other words, country risk can help us to understand some of the risks that may have negative impacts on an investment in tourism development.
We make sure to include country risk in project valuations. Specifically, country risk is a component of a particular project’s overall risk beta. Analogous to the beta in the capital asset pricing model (CAPM) for public equities, risk determines, more or less, the extra return that is required in order to justify a heightened level of risk.
Since we try to maintain below-market, ‘patient capital’ rates of interest on our investments, we have a strong incentive to seek out projects with low beta. In other words, it’s our hope that our project portfolio is doing all of the right things to minimize risk in all its forms.
In order to even be considered for investment, then, project owners must demonstrate a strong commitment to managing their project’s environmental and social impacts.
Because we focused on Mexico, for better or worse we have had to confront a string of negative news, which, using our approach, raises the beta of investment opportunities in Mexico. On the other hand, a recession might make North American consumers more likely to visit Mexico over more far-flung destinations, which could raise the alpha of ecotourism projects in that country. A few more years are probably needed to know if that's true.
