Tail-risk hedging, a hot topic in the immediate aftermath of the global financial crisis, is showing signs of coming back in fashion Down Under, industry veterans say.
But if tail risk's previous incarnation was symbolized by an elusive black swan, this time around the risks that investors are grappling with are all too obvious: equity market valuations puffed up by the same flood of central bank liquidity driving bond yields to record lows, effectively robbing fixed income of its defensive qualities.
Fears of a “substantial correction” for equity markets are boosting interest in tail-risk hedging globally, said Michael Connor, an executive vice president and a member of the product management group at Pacific Investment Management Co., Newport Beach, Calif.
But “there's been particularly strong interest from investors with large equity allocations, who often feel that, given low yields in fixed income, they have to remain invested in equities to hit their return targets,” said Mr. Connor.
Australia, where asset allocators in that country's A$2 trillion ($1.54 trillion) superannuation retirement market typically maintain equity weights of 55% to 60% for their “balanced” default options, is one such market.
In an interview, Adrian Stewart, the Sydney-based executive vice president and head of PIMCO Australia, said interest in tail-risk hedging among Australian superannuation funds has “really picked up” this year, with PIMCO garnering two “very large” institutional mandates over the past six months. He declined to name the clients.
Other asset owners say they're moving to put hedges in place. Kristian Fok, executive manager-investment strategy with Cbus, the A$27 billion superannuation fund for Australia's construction sector, said tail-risk hedging is one of several initiatives his Melbourne-based fund has “spent time on” this year, with plans to present its investment committee with a proposal for consideration in the coming months.
“Our approach is less around black swan scenarios and more around having additional portfolio risk management tools, particularly considering equities risks and bond pricing,” said Mr. Fok.
Mr. Stewart said the movement PIMCO is seeing now suggests asset owners increasingly are willing to be “pre-emptive ... not wanting to leave it to the wrong time in the cycle to think about things.”