Market volatility is the biggest perceived risk in the next 12 months according to institutional investors questioned for the latest biannual RiskMonitor survey from Allianz Global Investors. This was followed by sovereign debt and falling equity markets.

Sixth months ago volatility was ranked fourth and interest rate risks were perceived the biggest risk at the time. The share of respondents seeing volatility as a major risk has risen with 16% to 89% since the last survey was conducted.

Worries about sovereign debt and further sharp drops in equity markets have also increased, as more than a third perceived sovereign debt as a “huge” risk, more than any other risk category.

Thomas Wiesemann, chief market officer of AllianzGI in Europe, comments: “Nearly all indicators show a rising concern regarding capital market risks which is subsumed by the high concern on volatility. But remaining in the ‘risk off’ mode for longer will be dangerous for investors since the current low interest rate environment is generating insufficient returns to match investors’ liabilities, sometimes even negative real returns. If investors want to navigate these volatile markets with a limited risk budget and without giving up market upside potential, dynamic risk management strategies have become a necessity.”

Current interest rate levels are perceived as a major risk by 63%. Falling rates are perceived as a major risk by 42% and rising rates by 33% of respondents. Nearly 63% view tail risk as a major concern, compared to 48% six months ago.

Among all respondents, 80% believe the euro will survive under current circumstances. Regional differences exist though and although more than 90% of respondents in Italy, France and Germany have faith in the euro, they are also the most concerned about sovereign debt, with nearly 64% in France, 57% in Italy and 43% in Germany viewing it as a huge risk.

Asked about the most likely change with regard to the euro, 42% mentioned strengthened stability mechanisms, 19% the introduction of euro bonds and 11% the establishment of a joint fiscal regime. A quarter of the respondents view a split of the eurozone most likely to happen.

Two in five respondents use diversification methods to mitigate risk, followed by risk monitoring and duration management (both around 15%) and dynamic asset allocation (12%). Only 8% believe a traditional approach of managing risk by asset class is best suited to cope with current and future challenges. Thirty six per cent view managing asset liability risk as most appropriate, followed by breaking risk into categories rather than asset classes (29%) and managing risk by loss tolerance or expected loss (25%).

Reinhold Hafner, chief executive officer of risklab, a subsidiary of AllianzGI, said: “These results show how far institutional investors have already developed their strategic risk set up but the degree of its operational integration still differs. Investors have to shift from a backward-looking static framework based on a normal distribution to a forward-looking dynamic structure that explicitly accounts for empirical facts, such as fat tails and correlation breakdowns. Dynamic risk management strategies that go beyond pure diversification have passed the test during the financial crisis and will become more important.”

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