We’ve regularly posted our thoughts on the extreme risks (for example, see Library | Research & ideas | Other | Extreme risks) that should be acknowledged by the investment industry and there seem to be ever more voices joining the discussion, including Nick Bostrom at Oxford University’s Future of Humanity Institute (http://www.fhi.ox.ac.uk/). We were particularly interested in Cambridge University’s newly created Centre for the Study of Existential Risk (http://cser.org/). While our risk matrix has looked at issues such as resource scarcity, stagnation in economic growth, the likelihood of depression or global trade collapse, this new centre goes further into matters such as extreme tail climate change, systemic risks and fragile networks, molecular nanotechnology, biotech and artificial intelligence (the FT has carried a warning from Stephen Hawking on the risks of the latter, here). They provide a good context for distinguishing between what may be inconvenient risks and those that pose an existential threat to the human race. So, do we need to consider both extreme and existential risks? What are the impacts for our risk management and resiliency? Our guidance for investment institutions to adapt in recognition of extreme risks includes:
- A prioritisation exercise – worry about the events ‘that can kill you’ – that is, permanently impair the investor’s mission
- Doing the simple things. These would include ensuring the portfolio is as diversified across as many return drivers as possible; diversifying within asset classes; and creating a strategic allocation to cash to provide optionality
- And adding greater complexity over time (structured protection), assuming it passes a considered cost/benefit analysis.
The difficulty with this topic is going from the thinking to practically different portfolios. We are hopeful that the wider research agenda of the Institute will help move us forward – are contingent events ‘easier to deal with’ if planning horizons are lengthened? Can we get to an investment belief that agrees with Aesop in that the tortoise (risk-averse, low-volatility, long-term portfolio) really does beat the hare (short-term, optimised portfolio)?