“Extreme risk is usually hidden and thus not taken into consideration by portfolio managers. The theory allows extreme events – large deviations from the mean – to be modelled, so there’s more accurate modelling of downside risk than a normal distribution. A higher level of extreme risk generally leads to larger levels of underperformance in down markets. It’s critical to monitor and manage ‘extreme risk’ as well as volatility at stock and portfolio levels. “When you hedge currencies, it tends to reduce volatility, so the positions are just as inclined to decline as to increase.”

Baker acknowledged the transparency and illiquidity risks in emerging and frontier markets, “but that’s part of what makes the markets more attractive from an active management viewpoint,” because it often resulted in the market incorrectly pricing stocks. At present, Cambridge is cautious about Brazil for the short-term, because “it’s relatively expensive. Investors have become carried away. We’ve reduced exposures. Brazil is more dependent on the mining sector.” Conversely, the group is overweight Russia “which is relatively cheap”, and had benefited from high oil prices. “Valuations have not adjusted to this. Russia has long-term corporate governance problems, but we think the market is overly discounting for this.”