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Should investors be scared of heights?

Equities are scaling new peaks, driven by what appears to be a market-friendly first-round result in the French presidential elections and Trump’s renewed talk of tax cuts, but Eoin Murray, Head of Investment at Hermes Investment Management, warns that investors should look through the near-universal positivity for signs of risk.

In the US, for instance, the tech-toned Nasdaq breached 6,000 for the first time, while the Dow Jones retook the lofty 21,000 barrier it originally claimed this March.

But can risk assets sustain a rapid ascent to greater heights? Is there solid upwards-sloping ground past the escarpment, or do investors face an unexpected tumble down a crevasse?

History suggests that investing at such altitudes typically requires some high-tensile risk management strategies. Looking ahead, our range of risk measures indicates that, at the very least, investors should check their carabiners are screwed tight before climbing further.

Why peak crisis is always in view
One of the fundamental aims of risk management is to avoid drawdowns during crises. Over time, the investment industry has developed an array of downside risk management strategies and tools to mitigate the worst outcomes.

Crises, though, are assumed to be rare events – black swans, if you like – yet the data suggest that they are far more common. For example, as figure 1 illustrates, from 1965 to 2010 the International Monetary Fund (IMF) responded to no fewer than 70 systemic