Clarisse A. Simonek explains why investors, in particular ‘universal owners’, must work together to tackle systemic risks and create an orderly transition in response to ‘unhedgeable risks’
In recent years, institutional investors have increasingly realised that traditional investment strategies, which focus solely on seeking alpha, are insufficient for tackling the complex challenges facing global economies. Notably, they are becoming more aware of ‘unhedgeable risks’—risks that cannot be effectively mitigated through conventional investment approaches. These risks often stem from systemic and existential threats, such as climate change, social inequality, and biodiversity loss.
Institutional investors, especially the so-called ‘universal owners’ such as large pension funds and sovereign wealth funds, with diversified portfolios representing a significant portion of the global market, have a unique role in addressing these systemic risks. In this context, systemic resilience becomes crucial as these investors aim to strengthen the broader financial system against such disruptions. Universal owners are also uniquely exposed to ‘unhedgeable risks’ at the system level.
A recent Cambridge study, to which I contributed, quantified the potential loss of diversified portfolios due to systemic shocks and assessed the extent to which these losses could be hedged. The study found that “no strategy will offer more than 50 per cent coverage” of the negative impacts of climate change.
This finding suggests that leveraging environmental, social, and governance (ESG factors) to enhance financial system stability might be a more effective strategy than merely seeking alpha.