ASIA, 9 September 2019 – The Thinking Ahead Institute's (TAI) Extreme risks 2019 report and ranking1, which categorises rare events that could have a high impact on global economic growth and asset returns, has a new top three: global temperature change, global trade collapse and cyber warfare.
The extreme risks 2019 ranking saw global temperature change climb to the top spot which covers scenarios where the planet becomes far less habitable. The number two extreme risk is the potential collapse of global trade, driven by the rise of protectionism, primarily due to developments in global politics over the past six years. Joining in third place is cyber warfare. As the world has become ever more connected, the risk of the internet being weaponised has also increased.
The Thinking Ahead Institute's top 15 extreme risks ranking for the first time includes: biodiversity collapse, abandonment of fiat money and cyber warfare, while those that have dropped out of the top 15 this year are: deflation, insurance crisis and terrorism. Those that have risen up the rankings this year are infrastructure failure (+8 places), as well as global trade collapse (+3) and currency crisis (+3). According to the report, the extreme risks that are less of a threat than in 2013 include stagnation, which has fallen eight places, as well as resource scarcity which lost top spot by falling three places.
Global temperature change, the number one ranked extreme risk in 2019, moves up from being ranked third in the last Extreme Risks report. Climate Change is also drawing increasingly significant attention among asset owners, savers and regulators in Asia Pacific.
"To navigate through this complex world, we suggest investors need to be open-minded, avoid concentrated risks, be sensitive to early warning signs, constantly adapt and always prepare for the worst."
Tim Hodgson
Head of the Thinking Ahead Group
Tim Hodgson, Head of the Thinking Ahead Group, said: "Our extreme risks ranking has seen the emergence of a general trend with financial risks falling down the rankings and non-financial extreme risks growing in significance. Global temperature change becomes the highest ranked risk due to our assessment of higher likelihood coupled with significant impact – in the extreme this would mean mass extinction.
"We believe that the world is subject to fundamental changes, whether environmental or political which will alter power balances. A complex world can and will deliver extreme outcomes that are hard to imagine when working with a normal distribution. That means extreme events are much more likely than previously thought. To navigate through this complex world, we suggest investors need to be open-minded, avoid concentrated risks, be sensitive to early warning signs, constantly adapt and always prepare for the worst."
The research suggests, broadly, there are three hedging strategies available to institutions:
Paul Colwell, Head of the Advisory Portfolio Group in Asia, Investments, at Willis Towers Watson, said local investors should look at a number of metrics in evaluating extreme risks and protecting their portfolio. "Typically stress testing focuses on high impact economic risks that are typically neither close to expected outcomes, nor at the extreme tails of potential outcomes. This is the realm of extreme risks, which are harder to quantify, but by their nature most damaging to investment return outcomes. A traditional stochastic asset model, while better than a mean/variance approach at considering tail risks, is still limited by its structure and parameters, but if you test portfolios under specific scenarios, the only limit is our imagination. So how can investors be adaptable in recognition of extreme risks? Prioritisation is the key."
What risks could permanently impair an investor's mission? The evaluation should identify which extreme risks matter, and which can be ignored. "For the former, consider an insurance strategy along with doing the 'simple things' – diversifying the portfolio across as many return drivers as possible and within asset classes, and potentially creating a strategic allocation to cash to provide optionality," Paul added.
"Greater complexity can be added over time, assuming it passes a considered cost/benefit analysis. This could involve adding long-dated derivative contracts in a contrarian manner, that is, when they are cheap rather than popular. There is also overlap between potential responses to extreme risks and the key recommendations from our current five-year outlook where markets are under-pricing downside risks, valuations for growth-related assets are still high, and we expect low returns on average over five years."
Willis Towers Watson believes that, in this environment there is no 'single answer' for portfolio construction. An investor's best chance at mission success lies in a combination of diversity, risk management, dynamism, best-in-class alpha and innovation.
| Rank | 2019 | 2013 | 2011 | 2009 |
|---|---|---|---|---|
| 1 | Global temperature change | Resource scarcity* | Depression | Depression |
| 2 | Global trade collapse | Stagnation | Sovereign default | Hyperinflation |
| 3 | Cyber warfare | Global temperature change | Hyperinflation | Excessive leverage |
| 4 | Resource scarcity* | Depression | Banking crisis | Currency crisis |
| 5 | Currency crisis | Global trade collapse< | Currency crisis | Banking crisis |
| 6 | Depression | Banking crisis | Climate change | Sovereign default |
| 7 | Infrastructure failure | Sovereign default | Political crisis | Climate change |
| 8 | Banking crisis | Currency crisis | Insurance crisis | Political crisis |
| 9 | Sovereign default | Deflation | Protectionism | Insurance crisis |
| 10 | Stagnation | Health progress backfire | Euro break-up | Protectionism |
| 11 | Biodiversity collapse | Nuclear contamination | Resource scarcity | Disunity in Europe |
| 12 | Health progress backfire | Extreme longevity | Major war | End of capitalism |
| 13 | Nuclear contamination | Insurance crisis | End of fiat money | End of fiat money |
| 14 | Abandonment of fiat money | Terrorism | Infrastructure failure | War |
| 15 | Extreme longevity | Infrastructure failure | Killer pandemic | Killer pandemic |
*Food/Water/Energy crisis
| Rank | Risk | Description |
|---|---|---|
| 1 | Global temperature change | Earth's climate tips into a less-habitable state (hot or cold) |
| 2 | Global trade collapse | A worldwide protectionist backlash against cross-border trade |
| 3 | Cyber warfare | Internet being weaponised that causes severe damage to virtual systems vital to the economy and even to hard infrastructure |
| 4 | Resource scarcity* | A major shortfall in the supply of food/water/energy |
| 5 | Currency crisis | Extreme movement between exchange rates |
| 6 | Depression | A deep trough in economic output with massive increase in unemployment |
| 7 | Infrastructure failure | An interruption of a major infrastructure network |
| 8 | Banking crisis | Banking activity halts due to lack of liquidity |
| 9 | Sovereign default | Non-payment by a major sovereign borrower |
| 10 | Stagnation | A prolonged period of little or no economic growth |
| 11 | Biodiversity collapse | A collapse in biodiversity, in which an accelerating number of species decline to extinction |
| 12 | Health progress backfire | Massive rise in morbidity or mental ill-health, antibiotic resistance |
| 13 | Nuclear contamination | A major nuclear disaster, leading to large radioactivity release and lethal effects |
| 14 | Abandonment of fiat money | A complete collapse in trust on governments and governments-backed paper currency |
| 15 | Extreme longevity | Significant increase in life expectancy overwhelms support systems |
** Our subjective measure based on the intensity and scope of the impact, the likelihood, and the degree of uncertainty in assessing the risk level.
The Thinking Ahead Institute was established in January 2015 and is a global not-for-profit investment research and innovation member group made up of engaged institutional asset owners and service providers committed to changing and improving the investment industry for the benefit of the end saver. It has over 40 members around the world and is an outgrowth of Willis Towers Watson Investments' Thinking Ahead Group which was set up in 2002.
1 A subjective scoring system to derive a ranking of these risks, and the change of ranking reflects a change of view regarding both impact and likelihood of each individual risk.
