Black Swan Hedge Funds

This insurance requires a constant and expensive series of complex options bets. For decades it was challenging even for mathematicians to produce, and mistakes were costly. Few beyond the most sophisticated hedge fund managers and proprietary trading desks bothered to try. But now tail-risk hedging is turning into an off-the-shelf product, thanks to advances in risk-management software and the analytical power of everyday computers. Tail-risk strategies vary, but the classic version works like this: A money manager places bets on options that are deeply “out of the money.” For example, the fund might have contracts that will pay off only if the S&P 500 drops sharply in a certain period. It will have to keep placing these bets over and over, generating costs for investors if the markets keep going up or just doesn’t fall enough.

With tail hedges you’re really not concerned if the market is down 10%, you’re only concerned what you are going to be paid if it’s down 30% or more.

The biggest black swan fund available to U.S. retail investors, the $490 million Cambria Tail Risk ETF. Cambria Tail Risk ETF shows the kind of endurance such investments can require. Over the past three tumultuous months, it’s gained about 1%, compared with a 6% loss for the S&P 500. In the first quarter of 2020, when Covid rocked the markets, it returned 24%. Over the stretch of the past five years, however, it’s lost a cumulative 24%, compared with a 72% total return for U.S. stocks.

Haworth’s 36 South runs one fund that aims to stay flat during calm periods, rather than losing money, but pays out less when markets fall.