Two years of economic and market turmoil mean that investors cannot ignore the chances of even the most extreme events like global depression or a killer pandemic, a leading investment consultancy said on Monday.

Watson Wyatt said in its study, Extreme Risks, that investors should prepare for everything from currency and banking crises to trade protectionism and even the end of capitalism.

The firm said it had drawn up the list to underline that risk management in investing cannot afford to ignore threats even in the bottom 5 percent of possible events and recommended ways of hedging -- a form of insurance -- against them.

The events of the last two years have demonstrated that risk management cannot afford to stop at the 95th percentile. We need to find a way to include very unlikely, but potentially high impact, events, Watson Wyatt said in the report.

Its 15 extreme risks were ranked in order as of mid-year.

They were economic depression, hyperinflation, excessive leverage, a currency crisis, a banking crisis, sovereign default, climate change, political crisis, insurance crisis, protectionism, disunity in Europe, the end of capitalism, the end of fiat money, war and a killer pandemic.

Of its top risk, economic depression, the firm said that while the immediate threat appeared to have been reduced by government action, there was now little governments could do if demand dropped again.

The risk from climate change, meanwhile, was anything from flooding to reduced agricultural output and countries in conflict over diminishing resources.

As for disunity in Europe, that the potential for the break up of the euro zone, a major threat to foreign lenders.

WHERE TO INVEST

But all would not be totally lost for investors if some of these extreme risks did come to pass, according to the study, with Watson Wyatt offering potential hedge positions.

Economic depression, for example, could be offset to some extent with globally-diversified long-dated sovereign nominal bonds.

Gold, which is currently at nominal record highs, was a hedge for a range of threats, including hyperinflation and a currency crisis, while going long pharmaceuticals/short airlines was seen as combating investment losses from a pandemic.

Not everything was hedgeable, however, including climate change and political crises that led to the rise of extremism.

As for the end of capitalism, Watson Wyatt said gold was the best holding, but admitted that in such circumstance investors should probably worry more about the return of' their investments than the return 'on' their investments.

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See the report at: http://www.watsonwyatt.com/europe/investment/2009-INV-00030.pdf

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Inflation Depression