Report Summary
The concept of managing tail risk as part of investors’ overall risk-management objectives is not new, but it has gained a considerable profile as a result of the major tail risk events that characterised the 2008-09 global financial crisis and subsequent market volatility. Both recent history and uncertainty about the future are reflected in changing attitudes to mitigating the impact of tail risk events, including raising levels of protection and reassessing the products and strategies used to protect portfolios.
In order to determine how changing perceptions of tail risk have affected the investment strategies of institutional investors, the Economist Intelligence Unit, on behalf of State Street Global Advisors, conducted a survey of over 300 investors from the US and Europe, including institutions, pension funds, family offices, consultants, asset managers, private banks and insurance funds.
Key findings of the survey include:
Tail risk events are always underestimated
Over one-half (51%) of survey respondents agree that even those investors who believe that they have a deep understanding of the notion of tail risk almost always underestimate its frequency and severity. Few respondents (14%) believe that most institutional investors have a very good grasp of the frequency and severity of tail risk events.
The next tail risk event is expected imminently, stemming from Europe
Although tail risk events are by definition unpredictable, investors are very sensitive to their possibility. Almost three quarters (71%) of respondents believe that it is highly likely or likely that a significant tail risk event will occur in the next 12 months, with the cause expected to be related to ongoing European instability.
The benefits of diversification are not clear—but most investors continue to diversify
Almost one-half (47%) of respondents agree that the longheld belief that diversification of a portfolio across traditional asset classes of equities and bonds would provide some form of insulation against tail risk events has been disproved. There also has been a slight decline since the global financial crisis in the number of respondents who use diversification as protection against a future shock. Yet, despite evidence of increasing correlations, it is still selected as the most effective mitigation technique compared with other strategies.
Investors weigh both effectiveness and value when choosing strategies
Given that the rating for fund of hedge fund allocation was the lowest among selected strategies in terms of value, it is not surprising that allocation to this strategy has dropped significantly since the global financial crisis. But respondents have increased their use of “other alternative allocation” (such as commodities and infrastructure), managed futures/ CTA allocation and managed volatility equity strategies (or ‘minimum variance equity’), which have higher ratings in termsof value.
Investors are not entirely confident that they are protected from the next tail risk event
Only 20% of respondents were very confident, with 21% less than “somewhat confident” that they have some form of downside protection in place for the next significant market event. But the situation is better than before the crisis—almost three-quarters (73%) of respondents believe that, as a result of changing their strategic asset allocation, they are better prepared for the next major tail risk event.
