Institutional 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, according to the findings of the third annual Global RiskMonitor survey by Allianz Global Investors (AllianzGI).

Tail-risk has become a recurring topic of discussion since 2008 when investors were reminded that outlier events carry the potential for major market disruption and occur more frequently than normal bell curves would have us believe. Yet, traditional portfolio construction strategies leave investors unprepared for the frequency of such events.

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.

Commenting on the findings of the survey, Elizabeth Corley, CEO of AllianzGI, said:

“The results of this survey reveal an important paradox: while almost two-thirds of institutional investors have become increasingly worried about tail risk events since the financial crisis, a far smaller proportion are confident that they have access to the appropriate tools or solutions to deal with such events. With the anticipation of more frequent tail-risk events, there is an important role for active investment managers in helping clients to understand, classify, measure and ultimately mitigate the downside impact from these outlier events as well as providing opportunities on the upside.”

The next big threat

In today’s market environment, investors are faced with myriad 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.

Asset allocation trends

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 US 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 US 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.

Kristina Hooper, US Investment Strategist at AllianzGI, commented:

“The risk of a correction in the markets is growing with valuations continuing to rise, geo-political tensions festering and US monetary policy tightening on the horizon. 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. Risk assets are where investors should be in a time of financial repression but their associated risks need to be well managed.”

Alternative investments in a risky world

Institutions are calling for better risk management tools when investing in alternatives, without which the strong growth of this asset class could be stymied. Although three quarters (73%) of those surveyed make broad use of allocating to alternative asset types already, 40% of investors said they would be keen to increase their allocation to alternative assets if they were more confident of their or their manager’s ability to measure and manage associated risk. In particular, investors asked that asset managers focus on the measurement and management of liquidity risk rather than look to eliminate it. Around two in five investors (41%) believe there is a need for liquidity risk to achieve the best possible return and diversification benefits from alternatives.

Institutional Investors need risk management support

Institutional investors continue to rely on traditional risk management strategies, which could leave investors exposed to macro-economic and market shocks. Less conventional approaches, which protect against downside risk, such as direct hedging and risk budgeting are used by just over a third of investors (35% each) while liability-driven investment (26%) and managed volatility strategies (24%) are employed by an even smaller percentage of investors. Even though tail-risk is a major concern for investors fewer than three in 10 (27%) make use of strategies to hedge against tail-risk.

Tail-risk management is extremely challenging for many investors globally. Investors recognize the need for improvement to be better prepared for tail-risk events, but 56% believe tail-risk hedging strategies are too expensive. In addition, Institutional investors believe that tail-risks themselves (35%) and alternative products developed to manage them (36%) are not understood well enough.

Arun Ratra, Head of Global Solutions at AllianzGI, said:

“Risk management isn’t a choice. It isn’t something you do periodically. Investors are left unprepared and vulnerable to a plethora of threats when they utilize traditional risk management strategies. In today’s volatile market environment, investors need tools and solutions that will protect them from the threats we can see coming and the unknown threats yet to peak their heads. At AllianzGI, we are focused on helping clients to create the solutions that will deliver the outcomes they need to meet their investment objectives.”

About Risk Monitor

Allianz Global Investors’ 2015 RiskMonitor study is produced in collaboration with CoreData Research. To understand institutional investor attitudes towards risk, portfolio construction and asset allocation, 735 institutional investors across North America, Europe and Asia-Pacific were interviewed via an extensive global survey during the first quarter of 2015.

Respondents were drawn from a variety of ‘asset owning’ institutions; pension funds, foundations, endowments, sovereign wealth funds, family offices, banks and insurance companies.

Institutional respondents by regions: 235 Europe; 250 North America; 250 Asia Pacific.

To learn more about the report and to download global and regional findings, please visit: http://www.allianzgi.com/en/Risk-Management.

About Allianz Global Investors

Allianz Global Investors is a diversified active investment manager with a strong parent company and a culture of risk management. With 24 offices in 18 countries, we provide global investment and research capabilities with consultative local delivery. We have more than EUR 454 billion (USD 488 billion) in AUM for individuals, families and institutions worldwide and employ around 500 investment professionals.

At Allianz Global Investors, we follow a two-word philosophy: Understand. Act. It describes how we look at the world and how we behave. We aim to stand out as the investment partner our clients trust by listening closely to understand their challenges, then acting decisively to provide them with solutions that meet their needs.

Data as at 31 March 2015

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