A majority of global institutional investors believes the world economy will be hit by a significant tail-risk event in the next 12 months, and list Europe and China as the likely sources.

A survey of 310 institutional investors in Western Europe and the US, commissioned by State Street Global Advisors and conducted by the Economist Intelligence Unit, found that 71 per cent of institutions believe a tail-risk event was either “highly likely” or “likely.”

The technical definition of tail risk is an investment which moves more than three standard deviations from the mean of a normal distribution of returns.

Only 20 per cent of respondents said they were “very confident” they had some form of downside protection in place for a tail-risk event, although 61 per cent said they were “somewhat confident.”

Seventy-three per cent said that changes in their asset allocation made them better prepared and the survey showed investors had become more proactive in reducing the impact of such events.

It also revealed increases in asset allocation beyond traditional diversification techniques, with gains in allocation to alternatives such as commodities, infrastructure, and managed futures/commodity-trading advisor strategies. The allocation to fund-of-hedge-funds declined 9 per cent from pre-2008 levels.

“The report’s findings show that tail-risk events are nearly always underestimated but that, given the occurrence of a number of these events in recent years, sensitivity among institutional investors has increased,” said Niall O’Leary, managing director and head of EMEA portfolio strategy at State Street Global Advisors.

O’Leary said institutions had been slow to adopt mitigation strategies, even though investors saw this as an integral part of a comprehensive investment plan.

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