Institutional investors still reeling from the impact of the COVID-19 pandemic know the risks of unlikely, but devastating “black swan” events. However, many are ill-prepared for the ones they fear the most, according to a new survey from PGIM, the $1.2 trillion global investment management business of Prudential Financial, Inc.
The survey of 400 senior investment decision-makers at institutional investors in Australia, China, Germany, Japan, the U.K. and the U.S. with combined assets under management of more than $12 trillion, found that while tail risks varied by region, the predominant concerns center around the relationship between the U.S. and China, market function in times of stress, and the dependence on technology within financial markets. While over half of large institutions ($50 billion and above) actively monitor tail risks, overall for institutions of any size, less than 4 in 10 do so (38%). A tiny proportion (3%) of institutions have a dedicated tail-risk manager, and less than a third (32%) prepare specific risk response plans.
“Too often, investors are surprised by things that in retrospect were staring them in the face,” said Shehriyar Antia, head of Thematic Research for PGIM. “The pandemic, the global financial crisis, the dot-com bubble — these events were all foreseeable to different degrees. Financial institutions must either gameplan for the unexpected, or expect to be blindsided.”
Presented with geopolitical, economic, social and environmental scenarios ranging from a eurozone country debt default to a nuclear attack, respondents named their top three tail risks:
By definition, tail risks are rare and unexpected, which makes them exceedingly difficult to prepare for. But there are ways investors can hedge their bets.
“The best insurance against such rare and complex events is taking a long-term view and diversifying portfolios,” advised Antia. “Active managers can build portfolio strategies that will protect investors in a variety of scenarios.”
Monitoring leverage, collateral arrangements, and liquidity positions through these shocks can help investors avoid becoming a forced seller while the event is unfolding. When considering risks that are subject to extreme outcomes (and potentially not diversifiable), investors should also consider stress testing as opposed to looking at traditional statistical measures that make assumptions which may not be realistic for some exposures.
For more information and country-specific data, read the full report: 2022 Global Risk Report: Tail Risks.
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