Almost half of investors say portfolio diversification has been disproven as an effective risk-mitigation strategy
Seventy-one percent of institutional investors believe an extreme shock to global financial markets, most probably linked to the European sovereign debt crisis, is ‘likely’ or ‘highly likely’ in the next 12 months, according to a study commissioned by State Street Global Advisors.
The main concern of 36 percent of investors is that the global economy will be plunged into recession, according to the survey carried out under commission by the Economist Intelligence Unit (EIU).
Thirty-three percent of institutional investors believe the shock, or ‘tail risk’, could be triggered by a break-up of the eurozone, while 29 percent fear it will start with Greece exiting the eurozone.
Other concerns vary widely, with 21 percent fearing the trigger will come in the form of the US slipping back into recession, 17 percent foreseeing political deadlock in the US thanks to the ‘fiscal cliff’ it faces toward the end of the year, 15 percent predicting a possible sharp slowdown in China’s economy, 9 percent predicting an oil price shock and 8 percent fearing a rise in protectionism.
‘Concerns over Europe are still looming large in the minds of investors, with worries over the global economy and the possibility of the US returning to recession coming further behind, albeit still with a significant percentage of votes,’ states the report.
‘The implications of these expectations are potentially twofold: the investment community is aware of and preparing for major risks and, although Europe remains at the center, other concerns are also being taken extremely seriously.’
The study also finds that 51 percent of institutional investors say even experts on the topic of tail risk ‘almost always underestimate its frequency and severity.’
And only 14 percent of those surveyed believe most institutional investors have a very good grasp of the frequency and severity of tail risk events.
Just under half (47 percent) of institutional investors believe diversifying their portfolios across various classes of equities will mitigate risks during tail risk events.
‘Despite evidence of increasing correlations, it is still selected as the most effective mitigation technique compared with other strategies,’ the study concludes.
More than three quarters (76 percent) of investors surveyed have diversification strategies in place to mitigate risks, although that number has declined from 81 percent of investors before the global financial crisis. Risk-budgeting techniques are the second-most common technique for mitigating risks.
The study was carried out in June and July of this year; 310 institutional investors in the US and western Europe were interviewed, according to the EIU.
Six experts from asset-management firms, private banks, pension funds and academia were also interviewed in greater depth.
