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%).