As part of its statutory objective to “protect and enhance financial stability in the UK”, the Bank of England sets out to identify risks to the country’s financial system. One of the ways it goes about this is with a twice-yearly survey of the perceptions of such risks among market participants – in other words, professional investors such as asset managers, banks, hedge funds, insurers and so forth.
The results are published every June and December as the Bank of England’s Systemic risk survey and, from the most recent offering, we learn ‘geopolitical risk’ is viewed as a key risk by 57% of respondents – second only to the 61% polled by ‘risk of an economic downturn’ and some way ahead of the 40% racked up by both ‘sovereign risk’ and ‘risk of property price falls’.
Now, with all that has been going on in the world of late, this is unlikely to come as much of a surprise. What is surprising though or at least, we would suggest, worthy of note is the way geopolitical risk is seen as so much more of an issue now than at any other time in the history of the survey. As the chart below shows, it has never previously polled more than 11% and once even attracted zero interest.
Source: Bank of England Systemic Risk Surveys - Financial Stability Report June 2014
We are, it seems, back in the realms of the ‘availability heuristic’ – the behavioural finance idea that human beings tend to ascribe greater significance to more recent events. A more everyday example of this than the current heightened awareness of geopolitical risk would be the way a driver immediately slows down after being surprised by a speed camera only to accelerate a few miles along the road.
When investors have been reminded a particular risk exists – whether it be geopolitical or perhaps any of the almost 20 others flagged up in the Bank’s survey – there is a danger they will ascribe too much significance to it. By the same token, just because a particular risk has slipped out of the headlines, it does not mean it has gone away or that investors should start feeling complacent about it.
None of which is to suggest that the 57% of professional investors citing geopolitical risk as key in the current survey constitutes an overreaction or indeed an under-reaction to current events but it is at least interesting to note, for example, that at the height of the eurozone crisis in 2012, sovereign risk polled 79% in the Bank’s June survey and was up to 94% six months later.
Back in 2008 meanwhile, ‘risk of financial institution failure or distress’ was – again not that surprisingly – cited as a key risk by 85% of respondents. In the six years since, however, it has never polled higher than 33% – although it may be interesting to see this December’s survey, bearing in mind the results of the ECB’s review into the health of eurozone banks should be made known next month.
Here on The Value Perspective, we would argue a more balanced and pragmatic approach for investors to adopt on risk is to ensure you always pay sensible prices for the assets you buy as this will help factor a reasonable margin of safety into your portfolio. Such a value-based approach will not of course guarantee you never lose money as the result of one or more adverse situations but history suggests it can serve to shift the odds against such an eventuality more in your favour.