New perception of risk: focus on drawdown and capital impairment

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While investment risk supervision remains paramount for asset managers, the perception of risk and its main features has undoubtedly changed in the recent years. Investors increasingly require new approaches to risk in light of changes in financial market conditions and increasing requirements on the regulatory front.

Managing drawdowns and capital impairment

In a survey conducted between August and December 2015, Pioneer Investments asked Wholesale, IFA and Institutional Investors across Europe and Asia to express their views about risk.

What aspects of risk are most relevant to you now?

Source: Pioneer Investments 2015 Professional Investors’ Survey

Portfolio drawdown was, unsurprisingly, the main risk identified by investors. Over 70% of respondents were worried about the possible consequences of a sharp decrease in value of their assets, with one third of those stressing about the extremely negative connotations of such an event.

The risk of permanent capital impairment was also perceived as being quite significant, with one respondent in four expressing extreme concern. This result is not surprising, considering capital preservation was the foremost objective identified by investors when defining their portfolios’ asset allocation.

In the aftermath of the global financial crisis, concerns over the outlook for returns from equities and bonds, combined with a rise in volatility, have led to a major rethink of portfolio construction and risk management. With the occurrence of ‘fat tail’ events becoming much more prominent in investors’ minds, a greater understanding about the different sources of risk a portfolio may be subject to has become of paramount importance, as has the capability to implement hedging strategies to “cut the tails”.

Measures helping investors to manage, or at least mitigate, those kinds of risks should therefore become an essential tool offered by asset managers among their products and services.

Multiple faces of risk across regions and investors

Relevance of risk aspects by type of investors

Source: Pioneer Investments 2015 Professional Investors’ Survey

The possibility of not being able to meet investment objectives was seen as a key threat for 65% of the survey’s respondents. Portfolio volatility was next in terms of relevance, followed by the risk of not beating a benchmark, which appeared to worry one investor out of two. Interestingly, on the back of very low – and sometimes negative – interest rates alongside fears of possible deflationary spirals, respondents appeared to pay little attention to inflation.

Refining these results further, we observed that financial advisors were more concerned about volatility than wholesale and Institutional investors, perhaps because they directly deal with the reactions of end investors. However, even for them, the risk of a permanent impairment of capital was the main concern.

Institutional investors also put the risk of incurring a capital loss at the top; however, this contingency appears to be a bit less relevant for third party professional fund buyers, especially those based in Europe. The main concern for European wholesale investors was a sudden portfolio drawdown, followed by the risk of not achieving their investment objectives. Meanwhile, Asian licensed intermediaries were highly worried about drawdowns – these investors were also the most vigilant tracking risk versus benchmark.

Addressing investors’ concerns through portfolio construction
In our view, the high consideration for risk highlighted in this report indicates that investors appear to be increasingly concerned about the occurrence of extreme market events, as is often observed in periods of high distress and uncertainty.

Multiple geopolitical risks, subpar growth for global economies and fears of possible policy mistakes from monetary and fiscal authorities are weighing on the mood of professional investors, as well as their views on how to manage their portfolios in an environment of low expected returns across many asset classes.

In this challenging investment landscape, it is the role of the asset manager to provide clients with tools, expertise and solutions in order to help them address some of these fears.

An investment approach that focuses on researching high conviction ideas, active risk taking, and effective risk management, pursued through robust portfolio construction can be extremely helpful in this environment.

Gabe Altbach is head of Global Strategy and Marketing at Pioneer Investment

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