Home / Big funds fear another shock but are slow to prepare for it

Pension funds and other institutional investors are slow to adopt new asset allocation strategies even though a clear majority fear another ‘tail risk’ event will occur in the next 12 months.

A survey of 310 large European and US-based investors, commissioned by State Street Global Advisors and conducted by the Economist Intelligence Unit, found that 71 per cent of big investors believe it is either “likely” or “highly likely” that a significant tail risk event will happen within a year.

Funds are changing their asset allocation strategies accordingly but this has been slow, according to Niall O’Leary, a managing director and head of EMEA portfolio strategy at SSgA in London.

“The research… shows that the benefits of diversification as a tail risk mitigation approach are unclear and investors are not entirely confident that they are sufficiently protected from the next event,” he says.

“The market is still very focused on the possibility of downside events and methods to protect against them. This increased awareness and the willingness to guard against these events are encouraging, but the pace of adopting tail risk strategies has been slow. Investors are still trying to decide which methods are best in terms of effectiveness and value and some concern persists that the tools currently available to investors are not adequate enough.”

The significance of this for investment operations and custody specialists is that funds are likely to become less reliant on sovereign bonds for risk mitigation and more reliant on alternatives such as infrastructure, commodities and managed futures. Equities allocations – already down from pre-2008 highs for global funds – are likely to drift lower on average.

When asked what is the biggest challenge implementing these strategies, 64 per cent said “liquidity of the underlying investments”.
A tail risk event is defined as an investment which moves more than three standard deviations from the mean of a normal distribution of returns.

The full report can be accessed here.