Sovereign risk may seem a world away from Australia. But for many ASX small caps, particularly mining and energy stocks with operations in developing countries, it is something that must be grappled with.

Examples in recent years include Tanzania where in July 2017 the government (without warning) introduced radical changes to the Mining Act and investors were scared away from affected companies.

A more recent example is in Latin America, particularly Chile, where last month protestors targeted lithium mining operations.

 

How to handle sovereign risk

Stephen Panizza from Federation Asset Management told Stockhead sovereign risk was a reality for companies wherever they operated.

Federation is the largest shareholder in Windlab (ASX:WND), which has wind farms in Australia, North America and Africa.

“You can’t pretend it [sovereign risk] goes away, but there are ways of managing it,” Panizza said.

“I’m not familiar with [the Tanzanian mining disputes] but I’ve worked for 10-15 years in Asia.

“From time to time you have events where governments have changed and there are changes that can directly impact your investments.”

He told Stockhead it was easy to associate sovereign risk with developing countries, but Australia was not immune.

“But have a look at Australia – how many times have the rules changed? I’m not comparing us to Somalia but sovereign risk is everywhere – its just more acute [in certain countries],” Panizza said.

He said firms often bought political risk insurance as part of a broader package. Additionally, the bigger you are the safer you are – especially if you have the government on your side – particularly as an investor.

“The propensity for a government to do something and get another government offside is much less than the propensity offside to affect a small miner,” he said.

 

Benefit to the people

One criticism of mining companies in developing nations is that they are just taking minerals out of the ground to ship offshore without giving back to the local communities.

For example, Tanzanian President John Magufuli accused Barrick Gold subsidiary Acacia Mining of stealing from Tanzania – alleging unpaid taxes and royalties.

But Windlab’s Africa-based wind farms provide energy to a population that is booming and has energy needs that supply can’t keep pace with.

This makes it an appealing place to set up shop even though sovereign risk may be perceived as greater.

“In emerging markets like Africa you’re doing it [investing] because you need energy and it’s the cheapest and most effective form,” Panizza said.

“So for all these reasons it is quite appealing.

“Growth rates available in markets like Sub-Saharan Africa are large while in Australia its flat-lining.”

Stockhead contacted Windlab for comment earlier this week but the company would not comment beyond a referral to the company presentation and that it stood by its forecasts.

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