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Uncertainty, risk and control in the time of Covid-19

30 April 2020

The Covid-19 crisis has brought our relationship with uncertainty into sharp focus. It has shaken our feeling of control and called into question how we quantify risk.

While the confusion created by the virus has made everyone feel more exposed to risk, some are more used to quantifying these hazards. Asset managers and pension schemes spend every day considering the dangers associated with investment.

Risk is at the core of the investment process. No-one can ‘save’ – that’s to say set aside cash – for a pension. It would require such a significant proportion of your income that life over the short-term would become unaffordable.

As building a pension happens over a long period of time, it makes more sense to invest, even though this is riskier than squirreling away cash into a bank account every month. The long time period gives those investments a chance to recover should values dip.

But the crisis created by Covid-19 creates uncertainty. Although uncertainty and risk are terms which are often used interchangeably, they are very different creatures.

Uncertainty is a nebulous danger, which is hard to quantify whereas most risks can be assigned a probability of occurring. The virus has, however, introduced so much ambiguity that the usual parameters used to assess the hazard of a particular asset are no longer useful.

There are multiple examples of how Covid-19 has made it harder to assess the risk. Yesterday Fitch cut Italy’s credit rating to one notch above junk. Does this make another European sovereign debt crisis more likely?

HSBC announced it has set aside £2.4bn to cover loan and credit-card defaults expected during the resultant economic downturn. What are the implications for investors in asset-backed securities? And what does an economic downturn mean for the long-term prospects of corporate loans?

With social distancing measures set to continue, how will commercial property investments make money? Both offices and retail spaces require people to visit building which looks unlikely over the short-term. Does this make renting these spaces unviable?

It is the job of investment professionals to assess the impact of Covid-19 on the risks associated with these different asset classes. The recovery in financial markets would indicate a confidence investors can now carry out that task.

Much of this optimism can be traced back to the comfort provided by governments and central banks to provide the necessary monetary and fiscal tools to cushion the economic downturn caused by the impact of Covid-19. The decision by many European countries to start re-opening their economies is also providing a reason to be cheerful.

Promises to re-open gradually are, however, not the same as returning to life before Covid-19. Ambiguity remains. An uptick in infection rates is likely to encourage further lockdowns. With no idea of how long it will take before either a treatment or a vaccine for the virus emerges, it’s hard to quantify the long-term economic impact of this crisis.

But it’s not all gloomy. Much of the initial uncertainty surrounding Covid-19 – which created so much fear – was a lack of knowledge on how to tackle the emergent virus. We now have more information on which members of the population face the greatest threat from the disease and which suppression measures are effective.

In other words, the initial nebulous hazard posed by the disease is ebbing away and is starting to be replaced by a more rational assessment. We know older men are particularly vulnerable to the disease and social distancing is effective at disease suppression.

This resolution of uncertainty into more quantifiable risk factors helps to restore a sense of control. The virus is no longer an incomprehensible force but an enemy which can be understood.

Over time, the uncertainty over the long-term economic of Covid-19 will also start to be replaced by a more accurate risk assessment.

That will happen as countries carry out a real-time experiment balancing the competing demands to minimise deaths caused by the virus and maintaining economic growth. A solution will emerge. And then investors will be able to more accurately assess the risks associated with different assets.

Charlotte Moore - post author

Charlotte Moore has been a freelance journalist since 2006, with a solid technical understanding of a broad range of financial topics along with a previous incarnation as an investment analyst. Along with journalism, she has experience of producing written material for corporates and is seeking to expand this part of her business portfolio.