New research commissioned by State Street Global Advisors (SSgA), the asset management business of State Street Corporation (NYSE: STT), and written by the Economist Intelligence Unit (EIU), reveals that 71 percent of institutional investors believe it is “highly likely” or “likely” that significant tail risk event will occur in the next 12 months. Many investors, hit hard by the substantial drawdowns of recent tail events, are much more wary about the course of the next tail risk event. The research shows that the crisis in the Eurozone, the prospect of global or European recession and the slow-down in China among the concerns. SSgA commissioned the EIU to survey 310 institutional investors from across Western Europe and the US in June and July of this year. The findings are incorporated into a new report entitled “Managing Investments in Volatile Markets: How Institutional Investors are Guarding Against Tail Risk Events,” which reveals that although tail risk events are by definition unpredictable, investors have become far more sensitive to them, and are taking more proactive steps to reduce the impact they have on their investments. A tail risk, or extreme shock to financial markets, is technically defined as an investment that moves more than three standard deviations from the mean of a normal distribution of investment returns. Only 20 percent of respondents are “very confident” that they have some form of downside protection in place for the next significant event, with a further 61 percent “somewhat confident” of this. However, 73 percent of institutional investors believe that due to changes in their strategic asset allocation, they are better prepared for the next major tail risk event than they were before the start of the financial crisis. Niall O’Leary, managing director and head of EMEA portfolio strategy at State Street Global Advisors, said, “The report’s findings show that tail risk events are nearly always underestimated, but that given the occurrence of a number of these events in recent years, sensitivity amongst institutional investors to them has increased. However, the research also 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. Adoption of tail-risk mitigation strategies has been slow, although a large majority of investors now see managing this issue as an integral part of a comprehensive investment plan.”
Monica Woodley, managing editor at the Economist Intelligence Unit, said, “Tail risk has gained a considerable profile as a result of the major ‘shock’ events that characterised the financial crisis and the subsequent market volatility. Our research on behalf of SSgA sought to deepen understanding of the response of institutional investors to these market shocks and their remaining concerns.”Changes in Tail Risk Mitigation Strategies The data showed shifts in allocation – although interestingly, despite elevated concerns, the pace of change has been slower than expected. The widespread impact of tail risk events has resulted in a large proportion of investors reconsidering the products available to mitigate the impact of these events, beyond traditional diversification techniques. The survey showed gains in allocation to other alternatives, such as commodities and infrastructure, and managed futures/commodity trading advisor (CTA) strategies. The allocation to fund-of-hedge-funds declined significantly, with a 9 percentage point drop from pre-2008 figures. Barriers to tail risk protection strategies When asked to define the biggest challenges they face in allocating to their tail risk protection strategy, 64 percent of investors indicated liquidity of the underlying instruments. This statistic was followed by 54 percent who said regulatory adherence/understanding and risk aversion (49 percent). Niall O’Leary continued, “The market is still very focused on the possibility of down-side 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.” For a copy of the report ‘Managing Investments in Volatile Markets: How Institutional Investors are Guarding Against Tail Risk Events,’ visit: http://www.ssgainsight.com/reports/Economist_Managing_Tail_Risk_Report_pr.pdf. About State Street Global Advisors State Street Global Advisors (SSgA) is a global leader in asset management. The firm is relied on by sophisticated investors worldwide for its disciplined investment process, powerful global investment platform and access to every major asset class, capitalization range and style. SSgA is the asset management business of State Street Corporation, one of the world’s leading providers of financial services to institutional investors.
About the Economist Intelligence UnitThe Economist Intelligence Unit (EIU) is the world's leading resource for economic and business research, forecasting and analysis. It provides accurate and impartial intelligence for companies, government agencies, financial institutions and academic organisations around the globe, inspiring business leaders to act with confidence since 1946. EIU products include its flagship Country Reports service, providing political and economic analysis for 195 countries, and a portfolio of subscription-based data and forecasting services. The company also undertakes bespoke research and analysis projects on individual markets and business sectors. More information is available at www.eiu.com or follow us on www.twitter.com/theeiu The views expressed in this material are the views of State Street Global Advisors through the period ended 27 September 2012 and are subject to change based on market and other conditions. This document contains certain statements that may be deemed forward-looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected. EUMKT-2517