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Visualizing the Pyramid of Financial Risk

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Visualizing the Pyramid of Financial Risk

Visualizing the Pyramid of Financial Risk

Visualizing the Pyramid of Financial Risk

Financial risk falls under the limelight during market stress.

In periods of uncertainty, liquidity becomes especially valuable to investors. Assets that are more liquid are convertible into cash without losing much of their value. Consider how investors often flock to U.S. government bonds during economic turmoil thanks to their relative safety.

In the above graphic, we show how assets become both riskier and greater in size by dollar value as they move up Exter’s pyramid, using an adapted model from TradingView.

The Anatomy of Financial Risk

John Exter, an economist and former member of the Federal Reserve, developed the model of financial risk in the mid-1970s.

While he is most known for this inverted pyramid, he also was a founding governor of the Central Bank of Sri Lanka and was an advisor to Paul Volcker when he was chair of the Fed.

In the table below, some of the riskiest assets are derivatives. These are financial instruments based on the movements of an underlying security, such as currencies or commodities. They are often highly leveraged, meaning investors put very little money down to make these wagers, and in turn, can generate losses quickly.

Derivatives have a stunning $600 trillion in notional market value.

Asset TypeEstimated Global Value
Unless Otherwise Indicated
💹 Derivatives*$600T
🏦 Unfunded Government Liabilities$93.1T (U.S.)
🛢️ Non-Monetary Commodities$300T
👔 Private Business$22T (U.S.)
🏠Real Estate$326T
💼 Corporate & Municipal Bonds$14.3T (U.S.)
🏘 Securitized Debt$1.6T (U.S.)
📈Listed Stocks$120T
🏛 Government Bonds$128.3T
📃Treasury Bills$24.3T
💵 Paper Money**$8.3T (U.S.)
🧈 Gold$11.5T

*Represents notional value, the total value of the underlying contract. **Paper Money represents tangible currency including coins and bank notes. Gold is based on a spot price of $1,750 per oz and 205,238 tonnes. Unfunded government liabilities are debt obligations that have insufficient funds to pay for them.

Private business and real estate are also considered to have higher financial risk. Since there is no central marketplace where they can be sold quickly, they present higher operational risk and lower liquidity. Often, they are more difficult to convert into cash.

Moving down the pyramid are the $120 trillion in listed stocks, which have a centralized market, can trade in significant volumes, and disclose financials while adhering to securities regulations.

U.S. government bonds are considered to have some of the least financial risk globally, thanks to the U.S. never having defaulted on its debt, and the U.S. dollar’s role as a reserve currency. Short-term Treasuries are considered safer than longer-term bonds since they have a lower chance of default given the shorter holding period.

In the event of a liquidity squeeze, many consider cash to be king. Yet to Exter, gold was the safest asset thanks to its finite supply. Prior to 1971, most currencies were pegged to gold. In fact, the current era of fiat money—currencies that are not backed by a physical commodity—is a historical exception.

Domino Effects

During a market crisis, assets at the top of the pyramid tend to have the largest drops in value.

In this way, the degree of loss generally gets smaller the lower down you go in the pyramid. Relatively safer assets may rise in value due to higher demand. Here’s an example from the 2020 market crash that shows how asset classes responded:

AssetPrice Change (Jan 1 2020-Mar 21 2020)
U.S. Oil Index-61.4%
SPDR S&P 500 ETF Trust-29.5%
iShares 20+ Year Treasury Bond ETF
18.0%
S&P U.S. Ultra Short Treasury Bill & Bond Index
0.8%
SPDR Gold Shares ETF-1.3%

Source: Nasdaq (Mar 2020), S&P Global (May 2023)

As we can see in the table above, oil fell over 60% as uncertainty increased. Demand for oil typically falls during a weaker economy. By contrast, longer-dated bonds jumped in price.

It’s worth noting that the returns didn’t perfectly follow of the order of the pyramid, but the model can serve as a general guideline for how assets may respond to crisis.

Financial Risk in Today’s Environment

The recent U.S. banking turmoil spurred volatility in some financial assets.

Just as U.S. Treasuries saw extreme volatility since interest rate spikes led them to fall in value, U.S. bonds faced market turbulence. In this way, when safer assets experience uncertainty it can impact levels above in the pyramid.

Interestingly, volatility in bond markets has been higher than volatility in the S&P 500. This can be seen in the difference between the bond market volatility index, known as the MOVE Index, and the VIX Index, which tracks S&P 500 volatility. In April 2023, the difference between the MOVE Index and the VIX Index was near 20-year highs.

What this could point towards is that stocks have become mispriced relative to their true value. As interest rates rise to 16-year highs, borrowing costs have risen and this has hit corporate cash buffers and liquidity.

Overall, how current volatility impacts broader financial risk in the market could take time to materialize. Historically, it has taken roughly 18 months to two years for the true impact of monetary policy to filter through the market.

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Mapped: GDP Growth Forecasts by Country in 2024

Will global GDP growth continue to be resilient in 2024? This graphic shows the economic outlook for 191 economies around the world.

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This map shows GDP growth projections in 2024.

Mapped: GDP Growth Forecasts by Country in 2024

Resilient GDP growth and falling inflation are spurring a brighter outlook for 2024, although cautions remain across global economies.

While investors are hopeful that U.S. rate cuts could happen as early as May, the Fed has signaled that it won’t “declare victory” too soon. As countries around the world maneuver a complex landscape, they are faced with a scope of risks that include inflationary spikes, rising debt loads, and dwindling consumer savings.

This graphic shows global GDP growth projections in 2024, based on the International Monetary Fund (IMF) October 2023 Outlook and January 2024 update.

Global GDP Growth Outlook 2024

In 2024, real GDP growth is forecast to increase 3.1%, a slight rise from October’s outlook.

While positive growth is projected across all regions, it varies widely due to many factors spanning from the effects of higher borrowing costs to low consumer sentiment. Here are forecasts across 191 countries worldwide:

Country2024 Real GDP % Change (Projected)2023 Real GDP % Change (Estimate)
🇦🇱 Albania3.3%3.6%
🇩🇿 Algeria3.1%3.8%
🇦🇩 Andorra1.5%2.1%
🇦🇴 Angola3.3%1.3%
🇦🇬 Antigua and Barbuda5.4%5.6%
🇦🇷 Argentina2.8%-2.5%
🇦🇲 Armenia5.0%7.0%
🇦🇼 Aruba1.2%2.3%
🇦🇺 Australia1.2%1.8%
🇦🇹 Austria0.8%0.1%
🇦🇿 Azerbaijan2.5%2.5%
🇧🇸 The Bahamas1.8%2.7%
🇧🇭 Bahrain3.6%6.0%
🇧🇩 Bangladesh6.0%4.5%
🇧🇧 Barbados3.9%1.6%
🇧🇾 Belarus1.3%1.0%
🇧🇪 Belgium0.9%4.0%
🇧🇿 Belize3.0%5.5%
🇧🇯 Benin6.3%5.3%
🇧🇹 Bhutan3.0%1.8%
🇧🇴 Bolivia1.8%2.0%
🇧🇦 Bosnia and Herzegovina3.0%3.8%
🇧🇼 Botswana4.1%3.1%
🇧🇷 Brazil*1.7%-0.8%
🇧🇳 Brunei Darussalam3.5%1.7%
🇧🇬 Bulgaria3.2%4.4%
🇧🇫 Burkina Faso6.4%3.3%
🇧🇮 Burundi6.0%4.4%
🇨🇻 Cabo Verde4.5%5.6%
🇰🇭 Cambodia6.1%4.0%
🇨🇲 Cameroon4.2%1.3%
🇨🇦 Canada*1.4%1.0%
🇨🇫 Central African Republic2.5%4.0%
🇹🇩 Chad3.7%-0.5%
🇨🇱 Chile1.6%5.0%
🇨🇳 China*4.6%1.4%
🇨🇴 Colombia2.0%3.0%
🇰🇲 Comoros3.5%4.4%
🇨🇩 Democratic Republic of the Congo4.7%2.7%
🇨🇬 Republic of Congo4.4%6.2%
🇨🇷 Costa Rica3.2%2.2%
🇨🇮 Côte d'Ivoire6.6%0.2%
🇭🇷 Croatia2.6%6.7%
🇨🇾 Cyprus2.7%1.7%
🇨🇿 Czech Republic2.3%5.0%
🇩🇰 Denmark1.4%4.6%
🇩🇯 Djibouti6.0%3.0%
🇩🇲 Dominica4.6%1.4%
🇩🇴 Dominican Republic5.2%4.2%
🇪🇨 Ecuador1.8%2.2%
🇪🇬 Egypt3.6%-6.2%
🇸🇻 El Salvador1.9%-2.3%
🇬🇶 Equatorial Guinea-5.5%3.1%
🇪🇪 Estonia2.4%6.1%
🇸🇿 Eswatini3.3%7.5%
🇪🇹 Ethiopia6.2%-0.1%
🇫🇯 Fiji3.9%1.0%
🇫🇮 Finland1.0%2.8%
🇫🇷 France*1.0%6.2%
🇬🇦 Gabon2.6%-0.5%
🇬🇲 The Gambia6.2%1.2%
🇬🇪 Georgia4.8%2.5%
🇩🇪 Germany*0.5%3.9%
🇬🇭 Ghana2.7%3.4%
🇬🇷 Greece2.0%5.9%
🇬🇩 Grenada3.8%4.5%
🇬🇹 Guatemala3.5%38.4%
🇬🇳 Guinea5.6%-1.5%
🇬🇼 Guinea-Bissau5.0%2.9%
🇬🇾 Guyana26.6%4.4%
🇭🇹 Haiti1.4%-0.3%
🇭🇳 Honduras3.2%3.3%
🇭🇰 Hong Kong SAR2.9%6.3%
🇭🇺 Hungary3.1%5.0%
🇮🇸 Iceland1.7%-2.7%
🇮🇳 India*6.5%2.0%
🇮🇩 Indonesia5.0%3.0%
🇮🇷 Iran2.5%3.1%
🇮🇶 Iraq2.9%0.7%
🇮🇪 Ireland3.3%2.0%
🇮🇱 Israel3.0%2.0%
🇮🇹 Italy*0.7%2.6%
🇯🇲 Jamaica1.8%4.6%
🇯🇵 Japan*0.9%5.0%
🇯🇴 Jordan2.7%2.6%
🇰🇿 Kazakhstan4.2%1.4%
🇰🇪 Kenya5.3%3.8%
🇰🇮 Kiribati2.4%-0.6%
🇰🇷 Korea2.2%3.4%
🇽🇰 Kosovo4.0%4.0%
🇰🇼 Kuwait3.6%0.5%
🇰🇬 Kyrgyz Republic4.3%2.1%
🇱🇦 Lao P.D.R.4.0%4.6%
🇱🇻 Latvia2.6%12.5%
🇱🇸 Lesotho2.3%-0.2%
🇱🇷 Liberia5.3%-0.4%
🇱🇾 Libya7.5%74.4%
🇱🇹 Lithuania2.7%4.0%
🇱🇺 Luxembourg1.5%1.7%
🇲🇴 Macao SAR27.2%4.0%
🇲🇬 Madagascar4.8%8.1%
🇲🇼 Malawi3.3%4.5%
🇲🇾 Malaysia4.3%3.8%
🇲🇻 Maldives5.0%3.0%
🇲🇱 Mali4.8%4.5%
🇲🇹 Malta3.3%5.1%
🇲🇭 Marshall Islands3.0%3.2%
🇲🇷 Mauritania5.3%2.6%
🇲🇺 Mauritius3.8%2.0%
🇲🇽 Mexico*2.7%5.5%
🇫🇲 Micronesia3.1%4.5%
🇲🇩 Moldova4.3%2.4%
🇲🇳 Mongolia4.5%7.0%
🇲🇪 Montenegro3.7%2.6%
🇲🇦 Morocco3.6%2.8%
🇲🇿 Mozambique5.0%0.5%
🇲🇲 Myanmar2.6%0.8%
🇳🇦 Namibia2.7%0.6%
🇳🇷 Nauru1.3%1.1%
🇳🇵 Nepal5.0%3.0%
🇳🇱 Netherlands1.2%4.1%
🇳🇿 New Zealand1.0%2.9%
🇳🇮 Nicaragua3.3%2.5%
🇳🇪 Niger11.1%2.3%
🇳🇬 Nigeria*3.0%1.2%
🇲🇰 North Macedonia3.2%-0.5%
🇳🇴 Norway1.5%0.8%
🇴🇲 Oman2.7%6.0%
🇵🇰 Pakistan2.5%3.0%
🇵🇼 Palau12.4%4.5%
🇵🇦 Panama4.0%1.1%
🇵🇬 Papua New Guinea5.0%5.3%
🇵🇾 Paraguay3.8%0.6%
🇵🇪 Peru2.7%2.3%
🇵🇭 Philippines5.9%-0.7%
🇵🇱 Poland2.3%2.4%
🇵🇹 Portugal1.5%4.0%
🇵🇷 Puerto Rico-0.2%2.2%
🇶🇦 Qatar2.2%2.2%
🇷🇴 Romania3.8%6.2%
🇷🇺 Russia*2.6%0.5%
🇷🇼 Rwanda7.0%8.0%
🇼🇸 Samoa3.6%2.2%
🇸🇲 San Marino1.3%0.8%
🇸🇹 São Tomé and Príncipe2.4%4.1%
🇸🇦 Saudi Arabia*2.7%2.0%
🇸🇳 Senegal8.8%4.2%
🇷🇸 Serbia3.0%2.7%
🇸🇨 Seychelles3.9%1.0%
🇸🇱 Sierra Leone4.7%1.3%
🇸🇬 Singapore2.1%2.0%
🇸🇰 Slovak Republic2.5%2.5%
🇸🇮 Slovenia2.2%2.8%
🇸🇧 Solomon Islands2.4%0.9%
🇸🇴 Somalia3.7%3.5%
🇿🇦 South Africa*1.0%2.5%
🇸🇸 South Sudan4.2%4.9%
🇪🇸 Spain*1.5%3.2%
🇰🇳 St. Kitts and Nevis3.8%6.2%
🇱🇨 St. Lucia2.3%-18.3%
🇻🇨 St. Vincent and the Grenadines5.0%2.1%
🇸🇩 Sudan0.3%-0.7%
🇸🇷 Suriname3.0%0.9%
🇸🇪 Sweden0.6%4.0%
🇨🇭 Switzerland1.8%0.8%
🇹🇼 Taiwan3.0%6.5%
🇹🇯 Tajikistan5.0%5.2%
🇹🇿 Tanzania6.1%2.7%
🇹🇭 Thailand3.2%4.3%
🇹🇱 Timor-Leste3.1%5.6%
🇹🇬 Togo5.3%1.5%
🇹🇴 Tonga2.5%5.4%
🇹🇹 Trinidad and Tobago2.2%2.6%
🇹🇳 Tunisia1.9%2.5%
🇹🇷 Türkiye3.0%1.3%
🇹🇲 Turkmenistan2.1%2.5%
🇹🇻 Tuvalu3.5%3.9%
🇺🇬 Uganda5.7%4.6%
🇺🇦 Ukraine3.2%2.0%
🇦🇪 United Arab Emirates4.0%3.4%
🇬🇧 United Kingdom*0.6%0.5%
🇺🇸 U.S.*2.1%2.1%
🇺🇾 Uruguay3.3%1.0%
🇺🇿 Uzbekistan5.5%5.5%
🇻🇺 Vanuatu2.6%1.5%
🇻🇪 Venezuela4.5%4.0%
🇻🇳 Vietnam5.8%4.7%
🇵🇸 West Bank and Gaza2.7%3.0%
🇾🇪 Yemen2.0%-0.5%
🇿🇲 Zambia4.3%3.6%
🇿🇼 Zimbabwe3.6%4.1%

*Reflect updated figures from the January 2024 IMF Update

In the United States, GDP growth is projected to remain moderately strong, supported by rising real wages boosting consumption across the economy.

Yet compared to last year, growth is set to slow amid a softening labor market. In 2024, Citigroup announced it was laying off 20,000 employees after a disappointing year. Meanwhile, tech firms such as Google, Amazon, and Salesforce are reducing headcounts. Along with this, package delivery giant UPS announced 12,000 job cuts.

In China, property market woes are dragging on economic growth. Declining real estate values have impacted incomes, assets, and the public mood. Due to these headwinds, consumption growth is forecast to drop over the year.

Over in Latin America, Chile and Brazil were among the first emerging countries to hike interest rates in 2021—and they were some of the first to cut them last year. Thanks to improving domestic demand amid dissipating price spikes, the IMF upgraded the outlooks for Brazil and Mexico in 2024.

The lowest growth across all regions is forecast to be seen in Europe, at 0.9%. In late 2023, Signa, a multi-billion European property firm collapsed following the sharpest rise in interest rates in the European Union’s 25-year history. Also dimming the outlook is low consumer sentiment and the impact of high energy prices.

What are the Key Risks?

While no one holds a crystal ball, there are certain risks outlined by the IMF that could negatively impact global GDP growth:

  • Sharply Rising Commodity Prices: If geopolitical tensions escalate in the Israel-Hamas war, it could spillover into the broader region leading to spikes in energy prices. Over a third of global oil exports are based out of the region, in addition to 14% of global gas exports. Adding to this, 11% of international trade passes through the Red Sea, which has seen continued attacks between Iran-backed Houthi rebels and strikes from the U.S. and its allies.
  • Stubborn Inflation: A return of supply disruptions paired with an overheated labor market could add inflationary pressures, potentially leading to higher interest rates. In turn, stock markets could respond adversely and financial stability could deteriorate.
  • China’s Economy Slows: A property market rout could hurt domestic growth and consumer confidence, leading to declining consumption across the country. Accounting for nearly 19% of global GDP (PPP) in 2023, a slowing Chinese economy could impact countries that rely on trade with China.

While these risks remain present, the economy could witness positive surprises as well. Should inflation fall faster than expected, it would likely lead to monetary easing and a boost to global economic growth. Overall, the global economy defied expectations in 2023, and it may do the same in 2024.

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Chart: Is ESG Investing in Decline?

After the pandemic boom, ESG investments lost their luster amid high interest rates. Could they make a comeback?

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This graphic shows flows of ESG investments in the U.S.

Is ESG Investing in Decline?

These days, ESG investments have lost their luster given high interest rates, political backlash, and greenwashing scrutiny.

In 2021 during the pandemic boom, U.S. sustainable funds hit a record $358 billion in assets, up from $95 billion in 2017. But since then, investor interest has waned as higher borrowing costs impact capital-intensive clean tech stocks.

This graphic shows the drop in sustainable fund flows—often considered an indicator of investor sentiment—based on data from Morningstar.

Slowing Demand

In 2023, investor appetite cooled for sustainable investments, as fund flows notched their worst year on record.

Overall, flows sank $13 billion as fund performance lagged behind conventional funds. Adding to this, concerns surrounding the murkiness of environmental, social, and governance (ESG) ratings were put under the spotlight.

As ESG pushback intensified in U.S. politics, at least 165 anti-ESG bills were introduced in 2023. Politicians have claimed that ESG criteria negatively impacts financial returns, but evidence behind that is mixed.

While sustainable funds underperformed traditional funds in 2023, a separate study showed that ESG portfolios had as much as 6% excess returns annually compared to benchmark indexes between 2014 and 2020.

ESG Investments: A Closer Look

One key aspect of ESG funds is whether they hold investments that align with the UN Sustainable Development Goals (SDGs).

Globally, 542 funds with $125 billion in assets are associated with at least one of these objectives. The table below shows the top five SDGs, by ETF assets under management (AUM).

SDGGoalNumber of ETFsAUM
SDG 13Climate Action275$65.4B
SDG 7Affordable
and Clean Energy
80$15.3B
SDG 9Industry, Innovation,
and Infrastructure
49$13.4B
SDG 6Clean Water
and Sanitation
16$9.1B
SDG 11Sustainable Cities
and Communities
34$5.5B

Source: Trackinsight. As of January 7, 2024.

We can see that Climate Action is the highest overall, with companies held in these ETFs making commitments to lower emissions and advance sustainability.

For instance, Home Depot has cut electricity use by over 50% since 2010 in U.S. stores, and aims to use renewables for all of its electricity by 2030. In addition, Microsoft has committed to this goal through a number of initiatives, including providing access to clean water to over one million people across Indonesia, Brazil, India, and Mexico in 2023.

While investor interest has slowed, 35% of advisors said they used ESG funds last year, based on a Journal of Financial Planning survey. As the industry matures, it remains to be seen if ESG investments will see a resurgence, especially if interest rates fall in the coming years.

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