WHAT IS TAIL RISK?

Tail risk is a subject that has been receiving increasing attention from investors. The current economic and euro-dominated narrative and the (associated) exaggerated market movements have focused many investors' minds on possible extreme outcomes.

This paper explores the issue of tail risk management and considers the different approaches available to investors and their efficacy - more detailed material is available for those interested in exploring this further.

There are many definitions of "tail risk" but for the purposes of this paper we define it as the risk of unusually large investment portfolio losses over a short period of time. The interest in tail risk protection strategies has grown as investors seek to mitigate exposure to major systematic risks (mainly driven by the experience of the recent global financial crisis.

The main approaches to tail risk management are:

• Diversification strategies
  
• Hedging strategies, including:
  • Explicit hedges (for example, equity options)
  • Indirect hedges (for examples, credit default swaps)
  • Tail risk hedging funds (for example, asset management solutions)

The purpose of this paper is to give an introduction to each of these approaches. If you are interested in any of the topics raised in this paper, we would be pleased to provide further information.

Content of this paper includes:

• Should you be considering tail risk management?
• Diversification strategies
• Gold and US government bonds
• Low volatility equities
• Managed futures
• Direct hedges
• Indirect (or cross asset) hedges
• CBOE Volatility Index (VIX)
• Credit Default Swaps (CDS)
• Other cross-asset hedges
• Tail risk hedging funds
• Conclusion