In recent months, volatility has returned to investment markets, following several years of relative calm. Not surprisingly, this has brought tail risk protection strategies back to the forefront of investors’ attention.
While recent market volatility is relatively moderate from a medium-term perspective, we do believe there are fundamental reasons why downside risks continue to be elevated at present. We communicated as much in our Secular Outlook 2015 publication.
In particular, we currently assign a higher than normal probability of downside risks materialising and an adverse economic scenario playing out. A materialisation of some of the more extreme scenarios might see a 30%-50% drawdown in equities markets, similar to the 2000 Tech Bubble or 2008 Global Financial Crisis. As a result, we believe that clients should now consider adding a form of tail risk protection to their portfolios.
In this paper we look to inform the discussion of tail risk management strategies by articulating the main objective of tail risk management, providing an overview of the broad range of tail risk management strategies, assessing the strengths and weaknesses of the various strategies available, and setting out a framework for helping investors to determine which strategies are most appropriate for their circumstances.