Global risks push in­vestors to bulk up cash de­fenses

The Pak Banker - - MARKETS/SPORTS -

With the threat of a UK exit from the Euro­pean Union no longer just a dis­tant prospect, al­ready bat­tered in­vestors are shoring up de­fen­sive po­si­tions against a host of in­ten­si­fy­ing geopo­lit­i­cal risks, in­clud­ing a "Brexit".

In­vestors typ­i­cally dis­miss political gy­ra­tions as sideshows that might cause tem­po­rary mar­ket tur­moil but with lit­tle longterm im­pact. How­ever, with mar­kets volatile and as­sets from de­vel­oped mar­ket eq­ui­ties to emerg­ing mar­ket bonds a sea of red, the un­usu­ally high num­ber of geopo­lit­i­cal risks stalk­ing in­vestors this year could ex­pose al­ready bruised port­fo­lios to fur­ther losses.

"When you look into 2016, the one thing very clear is there are more fat tail risks out there than we've seen for a long time," said Paul O'Con­nor, co-head of multi-as­set at Hen­der­son Global In­vestors in Lon­don. Across most Hen­der­son funds, cash lev­els as a per­cent­age of to­tal as­sets are in the mid­teens, he said.

A fat tail risk refers to the higher-thannor­mal like­li­hood of an oth­er­wise un­usual event that would lead to ex­treme move­ments in re­turns, tech­ni­cally more than three stan­dard de­vi­a­tions from the mean.

Cur­rent key risks in­clude the UK leav­ing the euro zone, South China Sea ten­sions, Middle East con­flicts, fall­ing oil prices, the Euro­pean refugee cri­sis and a highly un­cer­tain U.S. Pres­i­den­tial race.

Cru­cially, tail risks are grow­ing at a time when global growth con­cerns and re­cent mar­ket dis­lo­ca­tion have made in­vestors crowd into a small num­ber of trades, no­tably long U.S. dol­lar, short oil and emerg­ing mar­ket po­si­tions.

That means tail risk events could spark a dra­matic un­wind­ing of th­ese po­si­tions as large num­bers of in­vestors seek to sell at the same time. "The fact that trades are cor­re­lated, trades are crowded, and we have a lot of fat tail risks leaves us own­ing a lot more cash than we typ­i­cally would," O'Con­nor said.

Hen­der­son is not alone in in­creas­ing cash. A Bank of Amer­ica Mer­rill Lynch sur­vey of 198 fund man­agers with com­bined as­sets of nearly $600 bil­lion re­leased last week found av­er­age cash bal­ances are up to 5.6 per­cent - the high­est level since Novem­ber 2001 with a U.S re­ces­sion dis­plac­ing a slow­down in China as the big­gest tail risk for global in­vestors.

The prospect that one of th­ese tail risks could fur­ther dam­age the frag­ile global econ­omy is what makes them so wor­ry­ing.

For Neil Dwayne, global strate­gist at Al­lianz Global In­vestors, which man­ages 427 bil­lion euros in as­sets glob­ally, a sharp spike in oil prices caused by an out­break of con­flict in the Middle East could world into re­ces­sion.

Equally, it would spark a rush to the ex­its by hedge funds who have crowded into trades bet­ting oil prices would re­main low for the fore­see­able fu­ture, caus­ing a mas­sive wave of sell­ing.

For ex­am­ple, net short po­si­tions in crude oil 3067651MSHT - a proxy for hedge fund po­si­tion­ing - re­main near record highs, ac­cord­ing to Thom­son Reuters data, in­di­cat­ing how vul­ner­a­ble the mar­ket is to the prospect of a re­ver­sal. "A spike in oil prices to $100 per bar­rel is the num­ber one geopo­lit­i­cal risk that the mar­kets are not pric­ing for," said Dwayne.

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