Navigating Risk in a Changing World — A Conversation with Robert Engle Part 2

We sat down with him to explore three pressing dimensions of risk that are currently shaping global investment decisions: geopolitical risk, market concentration, and climate risk. Each of these themes is structurally transforming the financial landscape, challenging traditional models and investment styles, as well as requiring new tools and insights.

Moderating the conversation is our Head of Quantitative Research, Dr. Gianluca De Nard, who has collaborated and published with Engle on topics such as climate risk modeling, volatility forecasting and portfolio optimization. Together, they offer a deep and pragmatic look into how risk is evolving—and how investors can prepare.

Part 2: Market Risk, Concentration, and Passive Investing

In recent years, equity markets—especially in the U.S.—have become more top-heavy than ever. The so-called Magnificent Seven tech stocks have dominated index returns, and with passive investing on the rise, capital is flowing ever more into the same names. But is this concentration creating new risks that investors need to consider and traditional models like GARCH or CAPM can’t capture?

Concentration as a Structural Feature

Robert Engle emphasizes that this isn’t just a statistical oddity—it’s a fundamental shift in how markets are pricing future innovation, especially around AI: “If we really foresee the benefits of AI being large, you want to be involved. Investors may be constructing what looks like a hedge portfolio—long tech, short the rest—hoping to benefit when AI delivers.”

This explains part of the valuation story: the market is pricing in transformative future growth. But when “everyone” crowds into the same trade, diversification—and resilience—starts to break down.

Engle says: “At some point, that hedge portfolio becomes the market itself. That’s where the non-diversification comes from.”

Are Traditional Risk Models Still Enough?

Models like GARCH or Shrinkage for modelling variances and correlations, as those proposed by Engle, De Nard and co-authors, are crucial for risk-optimized portfolios, however, they assume that returns and volatilities reflect short-term dynamics. But Engle cautions: “Volatility models don’t tell you about long-run risk. They show what to expect for a little while, but not the structural risk from long-term concentration.”

This becomes problematic when systemic tail risk may not show up in daily variance but rather in valuation extremes, fragility to shocks, or shared exposures across asset managers.

He suggests we need new tools—models that incorporate long-term exposure, thematic clustering, and regime shifts.

Is This an AI Bubble? Echoes of the Dot-Com Era

The recent tech rally has invited comparisons to past manias. Are we witnessing another bubble? Engle doesn’t declare one outright, but he notes clear valuation extremes: “We’re seeing simple valuation metrics—like P/E ratios—hit historical highs. And as we saw during the dot-com era, what goes up fast can correct hard.”

Gianluca De Nard adds that the concentration today mirrors past episodes—especially when evaluated indices overweight U.S. large caps. In his view, the illusion of diversification is real: “Some think the MSCI World is sufficient and globally diversified, but 72% of it is U.S.-based—mostly tech. That’s not a balanced portfolio.”

The Passive Investing Paradox

Engle doesn’t reject passive investing—but he warns that it may amplify systemic fragility, especially when everyone owns the same top-heavy portfolio: “Passive investing performed well recently, but it’s vulnerable in periods of stress. Strategies like equally weighted or minimum risk might ‘miss’ the highs—but they ‘avoid’ the cliff.”

He’s skeptical of blindly following market-cap weighting, especially when it comes at the cost of diversification across countries, sectors, and valuation regimes.

 Is It Systemic Risk? Not Exactly—But Close

Is the dominance of a few tech stocks a systemic risk? “Not in the 2008 sense,” Engle says. “Tech firms like the Magnificent Seven don’t borrow much—so banks aren’t exposed to their collapse in the same way.”

But the risk is still real—pension funds, hedge funds, and retail investors are all heavily exposed. A sharp drawdown could lead to widespread portfolio losses and panic behavior, even if banks are insulated.

What’s the Way Forward?

Rather than trying to time markets or predict bubbles, Engle and De Nard both advocate for risk-aware, adaptive strategies:

• Diversify across regions and sectors, not just companies.

• Use alternative weighting schemes like equal weight or constrained minimum variance to reduce concentration.

• Incorporate structural risk indicators—such as exposure to common volatility (CoVol) or thematic overvaluation.

“You can’t eliminate risk,” Engle concludes. “But you can be smarter about which ones you take.”

While concentration and valuation risk raise red flags in the short- and medium-term, the longest-duration risk facing investors today may be climate change. Yet unlike other risk factors, climate risk involves layers of political debate, scientific uncertainty, and often misleading ESG data.

In the final part of our interview, we move from near-term financial fragility to the structural risk of a changing planet—and ask: how should investors think about climate transition, green premiums, and the future of sustainable finance.