Institutions Unprepared for Tail-Risk

Two-thirds also say it's a bigger worry since the crisis.

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risk signInstitutional Investors globally believe tail-risk events, such as oil price shocks, new asset bubbles or geopolitical tensions, are becoming increasingly frequent due to the interconnectedness of global financial markets, finds the Global RiskMonitor survey by Allianz Global Investors (AllianzGI).

Nearly two-thirds (66%) of the 735 institutional investors surveyed think that tail-risk has become an increasing worry since the financial crisis. The majority of respondents, though, rely on traditional asset allocation and risk-management strategies to protect their portfolios with 61% utilizing asset class diversification and 56% geographic diversification.

With the inter-connectedness of markets, such diversification will become less effective in mitigating for drawdown risk. In fact, only 36% believe they have access to the appropriate tools or solutions for dealing with tail-risk.

In today’s market environment, investors are faced with various threats to the performance of their portfolios.

With the recent volatility in oil prices, geopolitical tension in Eastern Europe and the Middle East, sluggish growth in China, economic woes across Europe and a host of other economic and political uncertainties, investors are wary of being adversely affected by a tail risk event. Investors globally believe the most likely causes of upcoming tail events are oil price shocks (28%), sovereign default (24%), European politics (24%), new asset bubbles (24%) and a eurozone recession (21%).

Investors in the Americas and Asia-Pacific express a stronger belief that oil price shocks will be the cause of the next tail event (35% and 28%, respectively) while new asset bubbles (33%), along with sovereign default (29%) and geopolitical tensions (29%), are considered dangers by investors in Europe and the Middle East.

Institutional investor asset class sentiment is polarized in relation to traditional asset classes. Investors are bullish towards European and US equities and bearish on sovereign debt—developed and emerging market.

In terms of portfolio allocations, 30% of respondents globally plan to buy European and/or U.S. equities in the next 12 months due to their high upside potential. From a bearish perspective, 29% investors say they will sell sovereign debt and nearly a third (31%) of investors are adamant that the asset class will fail to perform over the next year.

Among those bullish on equities, significantly more investors are enamored with European equities because of their high return potential (61%), compared to only 44% for those bullish on U.S. equities. A smaller proportion (20%) of equity bulls attribute their overweighting of emerging market equities to high return potential, citing diversification (18%) and hedge against inflation (18%) almost as often.

“The risk of a correction in the markets is growing with valuations continuing to rise, geopolitical tensions festering and U.S. monetary policy tightening on the horizon,” says Kristina Hooper, U.S. investment strategist at AllianzGI. “In general, institutional investors’ current asset allocations make sense, but the problem is that many of these investors are not incorporating the proper risk management tools to protect these investments from market volatility.

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