September 27, 2012
majority of investors view tail-risk management as an important part of their
investment plans, but barriers remain for adopting risk-mitigation strategies. ---
Since the financial crisis, investors have started to
rethink tail-risk mitigation strategies, Niall O’Leary, head of EMEA portfolio
strategy for State Street Global Advisors (SSgA), said during a webinar. Tail
risk is an extreme shock to financial markets that shows up as infrequent
observations in the far left tail of a return distribution. It is technically
defined as an investment that moves more than three standard deviations from
the mean of a normal distribution of investment returns.
Investors are not entirely confident they are protected from
the next tail-risk event, O’Leary said, adding that research from the Economist
Intelligence Unit on behalf of SSgA shows institutional investors think they
almost always underestimate the frequency and severity of tail risk.
According to the research, 71% of respondents think it is
likely or highly likely that a significant tail risk will occur in the next
year. The Eurozone crisis, prospect of recession and the slowdown in China are
prominent concerns. With tail risk, however, O’Leary said the unexpected events
are the ones with the most potential to cause damage.
Research indicates significant geographical differences
between institutional investors’ views of the next tail-risk events. U.S.
investors predict the next event will be the global economy falling into
recession (48%); the Eurozone breaking up (37%); Europe sinking back into
recession (28%); Greece exiting the Euro (25%); and the U.S. slipping back into
recession (23%). European investors think the next tail risk will be Europe
slipping back into recession (40%); Greece exiting the Euro (32%); the Eurozone
breaking up (30%); the global economy falling into recession (29%); and major
bank insolvency (22%).