The Extreme Risks Threatening Investment Portfolios
(October 29, 2013) –The global financial meltdown should be considered yesterday’s news, as investors have new concerns keeping them awake at night, according to consultant Towers Watson.
In its annual assessment of extreme risks, Towers Watson said a crisis in the provision of food, water, and energy was the top of the three risks most likely to occur. Second in the group was economic stagnation, with a global temperature change being placed third.
This troika of events would have severe impacts both around the world and in the local areas in which they happened, Towers Watson said.
To help investors through the risk minefield, the consultant made suggestions about which assets to select to either avoid or take advantage of potential catastrophes.
These included securities providing exposure to resource in shortages or beneficiaries of substitution, globally-diversified long-dated sovereign nominal bonds, and land “in the ‘right’ place”.
Many large pension funds and other institutional investors have already begun buying up a diverse range of energy-producing firms and plants.
Last year’s winners of this extreme risks–which were mainly related to financial collapse–have fallen down the likelihood scale. The survey showed either a banking crisis or sovereign default was less likely than the three risks above.
In fact, sovereign default has the same risk profile as that of nuclear contamination. Interestingly, extreme longevity shocks were cited as a one in 100-year event.
Investors should take heart though. Towers Watson said the events that could cause the most damage to the widest population were also the least likely to occur, but investors should never discount the possibility of the infamous black swans.
“The power of the ranking system is that it combines and trades-off the four risk scores in a consistent manner,” the report said. “Different weights could be applied, but the importance of a ranking system is to challenge pre-conceptions (and mitigate black swan biases). Whatever the weights, the ranking highlights the risks to prioritise when it comes to management actions.”
End note: Towers Watson helpfully added to the report that risks scoring very highly in each section were discounted. The consultants said: “This is a result of the filtering process applied that excluded the bottom 15 extreme risks which we believe require less attention for the purpose of this paper. For example, we believe that an alien invasion is a potentially existential risk, with high uncertainty, very unlikely (one in every 100+ years) and with impacts affecting all future generations (pan-generational).”
To read the full list of extreme risks, and a study on the methodology, click here.
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