Strategic Tail Risk Management: A Pension Fund’s Perspective

Chris Limbach

This chapter will introduce and describe the concept of strategic tail risk management (STRM), an analytical framework developed by the author for a large Dutch public pension plan. It contains a number of different elements and moving parts, each requiring in-depth analysis, which – when applied in practice – will most likely result in different outcomes for different investors. STRM is agnostic with respect to an investor’s pre-existing beliefs regarding tail risk: whether they start out strongly in favour or strongly prejudiced against tail risk hedging, STRM is designed to be a useful “road map” to help institutional investors ask the right questions and think critically about their portfolios. The objective of STRM is to help investors identify and evaluate the relevant risks and exposures in their portfolios, thus enabling them to make informed and pragmatic decisions. The discussion in this chapter will follow the step-by-step sequence of STRM analysis.

There is no single, universally accepted definition of tail risk. For purposes of this discussion, the term will refer to a situation whereby an investment portfolio (and potentially the entire pension plan or investment