Global temperature change, global trade collapse and cyber warfare dominate the top three extreme risks that could have a significant impact on economic growth and asset returns, should they happen.

The Thinking Ahead Institute’s (TAI) Extreme risks 2019 report and ranking, 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.

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:

• Hold cash. Over long historical periods cash has held its real value through both episodes of deflation and inflation but there is no guarantee that this will be the case in the future.
• Derivatives. It is worth mentioning that cost and usefulness are often in opposition. The cost of derivatives protection can often be reduced by specifying more precise conditions – but the more precise the conditions, the greater the chance that they are not exactly met and hence the ‘insurance’ does not pay out.
• Hold a negatively-correlated asset. There is no single asset that will work against all possible bad outcomes. Further, there is no guarantee that the expected performance of the hedge asset will actually transpire in the future event.

Liang Yin, Senior Investment Consultant at the Thinking Ahead Group, said: “I see extreme risks thinking as an exercise for the mind. They remind us that it is naive and dangerous to cling to a single vision about the future. Yes, we do not know what the future holds. But our brains are more than capable of imagining multiple versions of the future. As investors, we are trying to navigate a highly volatile, uncertain, complex and ambiguous world. The scenarios are most effective when they are used, in a deliberately-created interactive environment, to make explicit - and to challenge - assumptions that underpin your investment portfolios or your business strategy.”
Reference: www.willistowerswatson.com