The sting in the tail risk

The sting in the tail risk

By Zaki Abushal
Investor demand for protection from downside risk has led to a number of recent tail-risk protection launches. But as September’s equities rally puts hedge funds in sight of positive year-end performance, are many abandoning safety hedges for beta?

Fear is the hottest property on the market. At least it was before September’s equities market rally moved the goal posts a little. Hedge funds, asset managers and investment banks have traditionally made a habit of monetising the sentiment of the investor base very quickly, never more so than now. But this time it isn’t a case of investment banks shoving new products down the throats of customers; instead it’s the customers, and in many cases investors, that are desperate for protection. At the lowest extreme, they want to mitigate against downside losses but also against those rare fat-tail events that are so destructive.

The ever-popular sovereign CDS spreads shown in the table opposite are just one of many risk measures that are hovering at dangerous levels. Stephen Antczak, head of US Credit Strategy at Société Générale Corporate and Investment Banking (SGCIB), admits that hedging and tail risk is “the hottest topic around” and he and his team have been busy informing investors of just that. The interest was such that Antczak, who with his team covered the topic in the SGCIB’s Credit Market Insights series in August and then in the middle of September, decided to host a conference in New York last week and may even host a similar conference in London to account for the topic’s appeal.

Of course, hedge funds haven’t missed out on the phenomenon driven by investors desperate to secure their gains. Two weeks ago, HFMWeek collated the views of investors (Navigating the market, HFM 199) and found that, alongside the need for liquidity, the majority expressed a desire for tail-risk/long volatility products.
Only last week, AQR, the hedge fund shop that has successfully developed a mutual fund range, recently launched a new product consolidating the firm’s advocacy of risk parity products. Its aim: “to lower investors’ exposure to equity risk and reduce tail risk or volatile downswings”.

This has been reflected in recent launches. Capula Investment Management launched the Capula Tail Risk Fund in March this year and was managing around $400m in assets by July, and at the end of last month, Bennelong Asset Management announced it would launch a tail-risk protection fund at the start of October – the
Bennelong Tempest Fund. The fund has been constructed to protect against market stress and tail-risk events, primarily using long options across all asset classes. “We are worried about our exposure to asset prices that are supported by more cheap leverage being thrown at a leverage problem,” said Bennelong’s CIO Paul Henry. “The more we travel, the more we realise everyone is in the same boat. Now we are doing something about it.”

And that’s just the problem. Everybody is in the same boat, paying lip service to value of hedging but put off by the expense, particular of those one-off, fat-tail events. To make matters worse, it’s no secret that correlations between asset classes have grown and grown. September’s rally was welcomed pretty unanimously by commentators and hedge funds, but most of all by investors, who watched the YTD performance figures with trepidation, as they hovered in low single-digits. September did wonders for the anxiety of investors but it also proved that, despite endless talk of alpha, the vast majority of hedge fund managers were happy to jump on the beta train and, if they can, ride it to the end of the year. And since everybody’s pretty much in the same trades, the risk of significant draw-downs are accentuated.

Of course, this raises the question: would an investor rather risk it all and chase equities and performance to the end of the year or stop and hedge some of that exposure even if it comes at a significant cost?


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