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Laxman Pai, Opalesque Asia: The top three tail risks for global institutional asset owners are an unexpected liquidity crunch, a military conflict in the Asia-Pacific region, and a major cyberattack, said a study.
According to a new survey conducted by PGIM, the money management subsidiary of Prudential Financial, institutional investors still reeling from the impact of the COVID-19 pandemic know the risks of unlikely but devastating "black swan" events, but many are ill-prepared for the ones they fear the most.
The survey of 400 senior investment decision-makers at institutional investors in Australia, China, Germany, Japan, the U.K., and the U.S. with combined assets under management of more than $12 trillion, found that while tail risks varied by region, the predominant concerns center around the relationship between the U.S. and China, market function in times of stress, and the dependence on technology within financial markets.
While over half of large institutions ($50 billion and above) actively monitor tail risks, overall for institutions of any size, less than 4 in 10 do so (38%). A tiny proportion (3%) of institutions have a dedicated tail-risk manager, and less than a third (32%) prepare specific risk response plans, said the report.
Presented with geopolitical, economic, social, and environmental scenarios ranging from a eurozone country debt default to a nuclear attack, respondents named their top three tail risks: An unexpected liquidity crunch in key capital markets (U.S. Treasuries, commodities, etc.) that results in a market crash; Military conflict in the Taiwan Strait or South China Sea, and a cyberattack disables a major financial platform or government agency for a significant period.
By definition, tail risks are rare and unexpected, which makes them exceedingly difficult to prepare for. But there are ways investors can hedge their bets.
According to the survey, investors acknowledge a variety of gaps and shortcomings in their investment risk monitoring, chief of which are failing to detect risks early (36%) or react to them speedily (41%).
More than a third also say they are unable to predict black swans (36%) and, worryingly, nearly 3 in 10 identify risk management complacency as a key challenge, it said.
Institutional investors deploy three main approaches to monitor investment risk: holistic monitoring across asset classes (44%), regular risk scenario analysis (41%), and regular evaluation of the effectiveness of risk management processes (41%).
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