How do institutional investors handle risk in a shifting global paradigm?

For the past four decades or so, the world has existed, broadly speaking, in a context of hyper globalization with massive and active growth pushing in all directions, he said, noting since around the fall of the Soviet Union, investors have been existing in a highly prosperous global paradigm. The U.S. has existed as the backbone of the world’s security system, ensuring relative stability within countries and markets investors care most about. On a broad scale, governments around the world have aspired to, and moved towards, transparency and a solid rule of law. They did so in conjunction with establishing market-friendly policies in the hopes that it would help them to move their respective economies forward, he said.

As well, during these years, generally open markets with highly mobile capital and labour forces have helped investors. “As an investor in long-term illiquid assets, we get to buy strategic assets in other countries and treaties and free trade agreements allow us to be treated like local investors.”

It is difficult for investing organizations to let go of the mindset that comes of having existed in that optimal scenario for so long. “It has been the ideal state for investors globally, particularly those residing in a middle power, in a relatively small country like Canada,” he said.

Today, investors are facing a new scenario, as demonstrated by events like the rise of U.S. president Donald Trump, the outcome of the Brexit vote and the subsequent fallout and most recently, the contention between Brazil’s government and other global powers as parts of the Amazon forest burn unchecked.

“When paradigms shift it creates uncertainty. We’re used to managing risk, but risk presumes a certain paradigm,” said Hausman. “The systems we have tend to be very effective, but when that paradigm changes we need to get a whole new toolbox to manage that uncertainty.”

The world is heading into a multi-polar status, after having existed in a uni-polar, U.S.-led economic scenario for so long, he said. “It means the U.S. begins to see itself more as a victim of globalization rather than its proponent. At the very same time you see the rise of China.”

However, the world’s power isn’t bound to be split exactly in two, as there are many other global players interested in growing their power, he added.

“The emerging paradigm is one where governments try to find authentic, and often simplistic solutions to quite complex problems.” Tariffs, Brexit, limiting visas for foreign workers in the U.S. and Donald Trump himself are all simple attempts to solve complex issues, he said.

Overall, the upshot for institutional investors, especially pension plans is that the market is far more perilous, but they have no choice but to invest, said Hausman. “We have to be fully invested. We have 70-year liabilities. We can’t just take our marbles and go home.”

The question then becomes, what is to be done? “You’ve got to have a portfolio that’s resilient. And we’ve got to somehow get over the hubris that we know what’s going to happen, because we don’t.”

As well, risk management systems need to become more scenario based as investors begin to contend with events that don’t fit the risk models they’ve been working with for years, he said.

“This is going to be suboptimal. I don’t want to give you the impression that we’re going to manage this and it’s all going to be sweetness and light,” he noted.

Further, local intelligence will remain key in investing, he said. The variation in possible scenarios needs to be accounted for in risk modelling in a world where countries as different as India, South Korea or Croatia are pursuing their own paths to growth in the absence of the dominant hegemony of the U.S. “Local intelligence means local partners. It means the ability to access expert networks that will tell you how to avoid the pitfalls and gain the alpha.”

Another reality to account for is that financial business models will need to change, he said. “Your business model that was developed based on a Washington-consensus view of the world is going to be useless when you’re trying to navigate China, India.”

Overall, diversity will be a necessity in addressing risk in this new global paradigm, he said. “Many types of diversity enhance our performance: gender diversity, diversity of background. But I want to express also that we need diversity in academic background, in outlook, interdisciplinary training, the training in social sciences and the humanities to look through paradigms, across silos. That’s how you manage uncertainty.”