Tail-risk hedging is the summer buzzword among institutional investors still unnerved by 2008's losses and scared anew by the May 6 flash crash and other global market events.
Investors are looking for ways to protect both equity and fixed-income investments from tail risk, typically defined as a low-probability, large deviation event that will negatively affect their investment.
“Tail-risk hedging is the talk of the conference circuit, but there's a hodgepodge of approaches. The real question is how to eliminate tail risk at no cost. That's the holy grail,” said Stephen L. Nesbitt, CEO of alternative investment consulting firm Cliffwater LLC, Marina del Rey, Calif.
Market losses and the volatility of the past 18 months have led many institutional investors “to recognize the risk of the '90s paradigm of heavy equity allocations” and convinced them that they need to “do something to mitigate tail risk,” he said.
“Tail-risk hedging clearly is a topic that's front and center among leading endowments,” said Deirdre Nectow, director of business development at investment consultant Cambridge Associates LLC, Boston. “Clients are increasing allocations or adding allocations to global macro, cash, gold equities and Treasury bonds. They also are reducing risk via non-traditional approaches such as the use of equity, interest rate or currency derivatives.”
Some money managers have seen enough demand from institutional clients for assistance in tail-risk hedging to persuade them to offer stand-alone hedge funds, customized hedge funds of funds or options overlay solutions.
Credit hedge fund manager Pine River Capital Management LP, Minnetonka, Minn., launched a tail-risk hedge fund that's “built like an insurance policy” in response to demand from institutional investors, said Angela Samfilippo, director of marketing and investor relations. The fund opened with $147 million from three institutional investors that Ms. Samfilippo said she could not identify. Pine River manages a total of $2 billion.
The strategy is built to profit from directionality, volatility and convexity during tail-risk events in equity and credit markets, Ms. Samfilippo said.
“We have always used tail-risk management in our multistrategy, relative value funds and it was fairly simple to carve out that approach and offer it in a master-feeder structure. It's very efficient, because all of our hedge funds now use the tail-risk fund, and it also is offered as a stand-alone fund to institutional clients. It's very liquid and transparent; all clients have exactly the same terms,” Ms. Samfilippo said. The fund charges a management fee, but no incentive fee because “the fund is not designed to generate alpha,” she said.
The fund could lose a minimum of between 1% and 1.5% per month or between 12% and 18% per year just from the cost of the options strategy. “But people anticipate more tail-risk events,” Ms. Samfilippo said, which is swelling Pine River's new-business pipeline with interest from existing clients and new prospects.