Tail Risk Hedging: An Investment Consultant’s Perspective

David Zanutto

This chapter will consider tail risk from the perspective of a large asset owner, such as public and private pension plans, endowments, foundations, sovereign wealth funds and other long-term institutional investors. It is informed by the author’s experience of advising chief investment officers (CIOs) and other top investment decision-makers on various aspects of asset allocation, portfolio construction and risk management. The focus will be on the practical tools and approaches that can be deployed by investment practitioners to mitigate and manage extreme left-tail risks.

Market events in 2002 and 2008 made investors painfully aware of the damage that tail risks can inflict on their portfolios. In the wake of the global financial crisis, many investors felt that they simply did not have the capacity for a repeat of the type of portfolio losses they incurred. Furthermore, these tail events appear to be occurring with greater frequency than what many investors may have previously expected.¹¹With respect to the S&P 500, rolling 65-day (ie, quarterly) losses worse than –20% occurred 5.3 times more frequently than a normal return distribution would suggest based on data from 1960