Tail Risk Protection

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hdas
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Tail Risk Protection

Post by hdas » Wed Aug 08, 2018 9:52 am

Hi All,
I have a very specific question: Has anybody seen evidence (real track record) that tail risk strategies work?

Context:
- The most interesting type of strategy involves using part of your portfolio to buy 'insurance' in the form of long out of the money options that would explode in value if a deep correction happens. The interesting part (see video linked) is that said insurance allows you leverage your equity portion.
- I'm really curious to see how this has performed overtime, specially considering that really bad events don't happen very often. However we do have sporadic episodes of exploding volatility (2011, Aug 2015, Feb 2018)
- One likely scenario is that when its said and done, the cost of the insurance + the manager fees erode most of the added value.

Video Explanation: https://youtu.be/LyGtiiGBEc8

Finally, here is a chart https://yhoo.it/2OQoz1b of YTD with the performance of VTI (Total Stock Market ETF), TAIL (Meb Faber Cambria product for tail protection ETF) and (HTUS - Blair Hull tactical allocation ETF). We can see that these particular implementations fail to really do well in times of stress (here comparing performance during the recent correction, not ytd)

Cheers, :greedy

Note:
Kindly abstain from unsubstantiated opinions or on liner bogle-truisms.

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vineviz
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Re: Tail Risk Protection

Post by vineviz » Wed Aug 08, 2018 9:57 am

hdas wrote:
Wed Aug 08, 2018 9:52 am
Has anybody seen evidence (real track record) that tail risk strategies work?
Nope. No one has.

As you suggested yourself, the reason is that the costs of maintaining the hedge during "normal" markets ends up being more than the benefits during the "tail risk" scenarios.

This true in no small part because the "tail risk" events have an infinite number of possible causes, so by trying to insure against them you end up being the general who is always fighting the last war.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

hdas
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Re: Tail Risk Protection

Post by hdas » Wed Aug 08, 2018 10:05 am

vineviz wrote:
Wed Aug 08, 2018 9:57 am
Nope. No one has.
This is not true. There are firms implementing these type of strategies. I was wondering if some BH's have been aproached by these firms and be able to see at least some historical real life results postive or negative.
vineviz wrote:
Wed Aug 08, 2018 9:57 am
This true in no small part because the "tail risk" events have an infinite number of possible causes, so by trying to insure against them you end up being the general who is always fighting the last war.
What do the # of causes have to do with put options returns during TSM crashes? Seems like you don't understand or are talking about something else.

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vineviz
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Re: Tail Risk Protection

Post by vineviz » Wed Aug 08, 2018 10:11 am

hdas wrote:
Wed Aug 08, 2018 10:05 am
vineviz wrote:
Wed Aug 08, 2018 9:57 am
Nope. No one has.
This is not true. There are firms implementing these type of strategies. I was wondering if some BH's have been aproached by these firms and be able to see at least some historical real life results postive or negative.
The world is full of salesmen, and their job is to sell.

You asked if there is real-world evidence that tail risk prevention strategies "work", and I'm telling you that there isn't any. Not on balance, and not with replicability.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

jminv
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Re: Tail Risk Protection

Post by jminv » Wed Aug 08, 2018 10:41 am

This would lead to lower absolute returns over the long term if it was a strategy you used continuously, ie, buy out of the money puts and continously roll them over throughout your life. The only way it would be more profitable is if you were fairly confident about a market peak at a given point of time and bought the puts, then the market agreed with you and tanked or if your investment horizon was short (you are old), you were worried about protecting principal but don't want to sell (perhaps so you don't realize a taxable gain on the underlying stock while working, want to delay until you have lower retirement income) and a huge crash occurred not long after buying the puts. Not continuously over a long horizon. If you look at how options are priced anyway, you are normally better off writing them than buying them for a long run strategy. The probability of far out of the money puts ever being profitable is low, they have no intrinsic value, you have volatility to deal with, time decay will be working against you, and the market has a positive skew. Due to the skew and option pricing, I'd be more likely to write out of the money puts than buy them as part of a long term strategy. If you did want to buy puts anyway you would buy leaps on spy or qqq and roll them over periodically to counteract the positive market skew and time decay.

The two ETFs you mention don't offer real tail risk protection, although TAIL comes closest. TAIL looks like a guaranteed way to go to zero over time but you're also paying them to hold treasuries as well. HTUS is a long-short ETF that uses some sort of proprietary model to decide whether to be long or short. If their model failed and they were long when they should have been short then how would this offer tail risk protection? It's an ETF that whose management goes back and forth on whether they should be a leveraged or an inverse ETF. I don't think their predictive power is any better than the next investor's so I would be unlikely to park any money with them. If you wanted to implement an out of the money put strategy you should do it yourself to cut out the management fees. Get an account at tastyworks, use an option screener to pick the leap you're interested in, and then buy it yourself.
Last edited by jminv on Wed Aug 08, 2018 10:56 am, edited 2 times in total.

Theoretical
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Re: Tail Risk Protection

Post by Theoretical » Wed Aug 08, 2018 10:54 am

No, it’s not a good strategy any more because the risk of crashes/black swans is now priced into those out of the money puts, and they’re very expensive, on the order of 1.5-2%+. Worse still, you’re only rewarded for the risk if the actual volatility exceeds the priced in implied volatility. Even without that, it’s only occasionally a good strategy (in times of a true bubble) that can still lose you lots of money along the way in a time and way that’s particularly irritating to our instincts: losing money persistently during bull market runups.

Given human behavior, there will likely come a time or bubble where these options are ridiculously cheap and wouldn’t provide this degree of problem, but the Big Short scenario of paying .5% to buy fire insurance on a burning explosives factory is unlikely to be repeated anytime soon.

hdas
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Re: Tail Risk Protection

Post by hdas » Thu Sep 20, 2018 3:36 pm

From the horse's mouth: https://youtu.be/PnqnGYQyzHg

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galeno
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Re: Tail Risk Protection

Post by galeno » Thu Sep 20, 2018 7:40 pm

The Boglehead way of tail risk protection:

Rick Ferri uses a lower % of more volatile equities (small cap value equity fund/ETF) and more bonds vs a higher % of less volatile equities (TSM) and less bonds (TBM).

E.g. 40% SCV + 60% TBM vs 60% TSM + 40% TBM.
AA = 40/55/5. Expected CAGR = 3.8%. GSD (5y) = 6.2%. USD inflation (10 y) = 1.8%. AWR = 4.0%. TER = 0.4%. Port Yield = 2.13%. Term = 34 yr. FI Duration = 6.2 yr. Portfolio survival probability = 95%.

Theoretical
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Re: Tail Risk Protection

Post by Theoretical » Thu Sep 20, 2018 7:45 pm

That’s Swedroe not Ferri. And the bonds are treasuries.

staythecourse
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Re: Tail Risk Protection

Post by staythecourse » Thu Sep 20, 2018 7:50 pm

hdas wrote:
Wed Aug 08, 2018 9:52 am
Kindly abstain from unsubstantiated opinions or on liner bogle-truisms.
Nothing to add just had a chuckle at what think was meant as one liner bogle-truism. Might have to steal that one.

Good luck.
"The stock market [fluctuation], therefore, is noise. A giant distraction from the business of investing.” | -Jack Bogle

Pelerus
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Re: Tail Risk Protection

Post by Pelerus » Thu Sep 20, 2018 7:58 pm

jminv wrote:
Wed Aug 08, 2018 10:41 am
I'd be more likely to write out of the money puts than buy them as part of a long term strategy.
Ah, the old harvesting nickels in front of a steamroller strategy. That’s how people blow up. And actually, this is not too dissimilar from the line of thinking that cost a lot of “clever” volatility sellers their whole nut back in February. What could go wrong, right?

If you want to sell puts, please keep them near the money - that way you know the score and aren’t caught like a deer in the headlights by the “once in a hundred year” event that seems to happen about once every five years now.

Additionally, it is near the money puts, not far OOM, that tend to be overpriced. People are willing to pay up to protect themselves from a small loss that they consider likely, less willing to pay up to protect themselves from a large loss they see as remote. So if you are selling the equivalent of insurance, sell policies on door dings, not tsunamis.

Theoretical
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Re: Tail Risk Protection

Post by Theoretical » Thu Sep 20, 2018 8:03 pm

Ditto and buy tail hedges so that you’re selling stuff near the money and buying for the black swan.

hdas
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Re: Tail Risk Protection

Post by hdas » Sun Sep 23, 2018 3:10 pm

Well, we finally have some numbers on the table.

Here's a letter to investors from the incumbent hedge fund. And here are the reported results.

Image

Some notes:

1. Only the shadow knows what is truly hidden behind those notes and disclosures in the final part of the report.
2. Results skewed by 2008 crisis, but OTOH that's when you want a fund like this to work.
3. Unless one sits closer to the fire to scrutinize the data, it's hard to draw any conclusions.

Here's a general comparative of diff risk mitigation strategies:

Image

For WSJ suscribers

CedarWaxWing
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Re: Tail Risk Protection

Post by CedarWaxWing » Sun Sep 23, 2018 4:47 pm

hdas wrote:
Wed Aug 08, 2018 9:52 am
Hi All,
I have a very specific question: Has anybody seen evidence (real track record) that tail risk strategies work?

Context:
- The most interesting type of strategy involves using part of your portfolio to buy 'insurance' in the form of long out of the money options that would explode in value if a deep correction happens. The interesting part (see video linked) is that said insurance allows you leverage your equity portion.
- I'm really curious to see how this has performed overtime, specially considering that really bad events don't happen very often. However we do have sporadic episodes of exploding volatility (2011, Aug 2015, Feb 2018)
- One likely scenario is that when its said and done, the cost of the insurance + the manager fees erode most of the added value.

Video Explanation: https://youtu.be/LyGtiiGBEc8

Finally, here is a chart https://yhoo.it/2OQoz1b of YTD with the performance of VTI (Total Stock Market ETF), TAIL (Meb Faber Cambria product for tail protection ETF) and (HTUS - Blair Hull tactical allocation ETF). We can see that these particular implementations fail to really do well in times of stress (here comparing performance during the recent correction, not ytd)

Cheers, :greedy

Note:
Kindly abstain from unsubstantiated opinions or on liner bogle-truisms.
I don't know much about these hedge products... but the video explanation looks to be like a simple, slick video graphic of how they want you to view what they do, with no factual information. No better than a late night tv ad my Alex Trebek selling life insurance with no physical required, guaranteed to accept your application.

Anything of that nature strikes me as something to stay away from, unless I can find accolades about the idea or product by smart people with no agenda, nothing to earn by the sale of that product. No reason to think their graphic has anything to do with facts.

columbia
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Re: Tail Risk Protection

Post by columbia » Sun Sep 23, 2018 5:48 pm

- One likely scenario is that when its said and done, the cost of the insurance + the manager fees erode most of the added value.
In general, this answers your question.

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willthrill81
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Re: Tail Risk Protection

Post by willthrill81 » Sun Sep 23, 2018 5:54 pm

I am a trend follower mainly due to a desire to minimize tail risk. The strategy I use has worked very well in the past, but it may not work so well going forward. I accept this.
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings

bluerafters
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Help Understanding Mark Spitznagel And Tail-risk Hedging?

Post by bluerafters » Mon Sep 24, 2018 4:41 pm

[Thread merged into here, see below. --admin LadyGeek]

https://www.worth.com/the-goat-whisperer/

I'm enjoy reading about strategies people use in Investing. (You never know if something might be useful down the road.) I initially found Spitznagel through Taleb, whom I enjoy, but can only take in small doses. Everything Mark says just remains obtuse, deliberately?, and I don't think I've ever read anything that reveals his actual positions.

Can anyone give me a [(removed) --admin LadyGeek] FAQ on tail hedging?

JackoC
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Re: Tail Risk Protection

Post by JackoC » Mon Sep 24, 2018 5:37 pm

hdas wrote:
Sun Sep 23, 2018 3:10 pm
Well, we finally have some numbers on the table.
Some notes:

1. Only the shadow knows what is truly hidden behind those notes and disclosures in the final part of the report.
2. Results skewed by 2008 crisis, but OTOH that's when you want a fund like this to work.
3. Unless one sits closer to the fire to scrutinize the data, it's hard to draw any conclusions.

Here's a general comparative of diff risk mitigation strategies:
Here's a blog piece from a couple of years ago with more specifics what Universa does, or did, or was doing in general at least as gleaned from examples in Spitznagel's (the CIO/quant behind this fund though Taleb helps market it) articles and books:
https://thefelderreport.com/2016/08/15/ ... portfolio/

I agree at least with the second part of a previous comment "+ the manager fees erode most of the added value" If an idea is generally valid, it's not so likely you come out ahead doing the exact proprietary strategy and paying the fees, as opposed to doing the simplified version in the manager's books and articles by yourself. And a brief search showed Universa having a $25mil minimum investment* as of some years ago so it's probably academic for most.

The simple version of the strategy in simplest terms seems to be, buying 2+ month maturity puts on the S&P, struck 30-35% below of the money, then selling and rolling into the next set of options after a month. There's also an idea of doing this only when the market is highly valued according to the Tobin Q.

*although they define investment a little differently than usual. That means you want them to hedge at least $25mil of stock portfolio, you only give them a small % of that to buy the hedges. Anyway still hardly a retail product, and I guess it's still not even if the $25mil figure has been lowered, Universa's website gives no such details, hardly any info at all.

timmy
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Re: Tail Risk Protection

Post by timmy » Mon Sep 24, 2018 6:00 pm

I've spent a lot of time looking at this. I've even tried it out, small dollars on puts.

It should work in theory. However, in my trials, the market was going up and I just found the whole thing tedious.

I've seen a lot of hypothetical models but no actual use cases (vs. say my own experience owning index funds).

Check out ...

https://mebfaber.com/2017/06/15/nervous ... -strategy/

Check out ...

https://www.universa.net/riskmitigation.html

Check out ...

As today's preeminent doomsday investor Mark Spitznagel describes his Daoist and roundabout investmentapproach, “one gains by losing and loses by gaining.”This is Austrian Investing, an archetypal, counterintuitive,and proven approach, gleaned from the 150-year-old Austrian School of economics, that is both timeless and exceedingly timely.

In The Dao of Capital, hedge fund manager and tail-hedging pioneer Mark Spitznagel—with one of the topreturns on capital of the financial crisis, as well as over acareer—takes us on a gripping, circuitous journey from theChicago trading pits, over the coniferous boreal forests andcanonical strategists from Warring States China to NapoleonicEurope to burgeoning industrial America, to the great economicthinkers of late 19th century Austria. We arrive at his centralinvestment methodology of Austrian Investing, where victorycomes not from waging the immediate decisive battle, but ratherfrom the roundabout approach of seeking the intermediatepositional advantage (what he calls shi), of aiming at theindirect means rather than directly at the ends. The monumentalchallenge is in seeing time differently, in a whole newintertemporal dimension, one that is so contrary to ourwiring.

Spitznagel is the first to condense the theories of Ludwig vonMises and his Austrian School of economics into a cohesiveand—as Spitznagel has shown—highly effective investmentmethodology. From identifying the monetary distortions andnon-randomness of stock market routs (Spitznagel's bread andbutter) to scorned highly-productive assets, in Ron Paul's wordsfrom the foreword, Spitznagel “brings Austrian economics fromthe ivory tower to the investment portfolio.”

The Dao of Capital provides a rare and accessible lookthrough the lens of one of today's great investors to discover aprofound harmony with the market process—a harmony that is soessential today.

JackoC
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Re: Tail Risk Protection

Post by JackoC » Mon Sep 24, 2018 10:04 pm

timmy wrote:
Mon Sep 24, 2018 6:00 pm
I've spent a lot of time looking at this. I've even tried it out, small dollars on puts.

It should work in theory. However, in my trials, the market was going up and I just found the whole thing tedious.

I've seen a lot of hypothetical models but no actual use cases (vs. say my own experience owning index funds).

Check out ...

https://mebfaber.com/2017/06/15/nervous ... -strategy/

Check out ...

https://www.universa.net/riskmitigation.html
The Meb Faber thing seems to be talking about buying 5% out of the money puts. The thing I linked, in turn linking to an article by Spitznagel is talking 30-35% OTM puts. Seems like fairly different strategies.

It's funny the Universa site stuff never mentions the term 'put option'. It's likewise with blurbs about Spitznagel and 'Austrian economics'. I'm puzzled what that has actually has to do with anything. Maybe I'm too simplistic. Which index put buying strategy yields which historical result? :D (directed at Universa).

I'm also still interested in the part where I linked about only doing this when the market is in the top quartile of historic Tobin Q. Measures like that (CAPE etc) have been historically high the whole time this fund has existed. I wonder if the idea is really for the fund to sit on its hands when/if the Tobin Q isn't historically high (setting aside debate on whether measures like that can be directly compared between era's). It specifically says though that constant put buying in expensive and cheap stock markets doesn't work in general. And that's the conventional wisdom, that it does *not* work because of the risk premium of the volatility skew (higher implied volatility for lower strike options). Because there's no 'natural' home for short positions in low strike stock index options with any end user. The people constantly short those options are delta hedgers who need a significant positive expected return 'picking up nickels' hedging those options out to a profit in normal times (because they sold them at generally implied volatility than subsequently realized volatility) v. getting 'run over by steamrollers' every once in a while when realized volatility spikes to where nobody can act fast enough to avoid being seriously burned by the negative convexity of being short those options. And Universa is generally willing it seems to mention the term 'positive convexity' for being long those options, even in some 'explanations' of that they do, with options apparently, which don't ever use the word 'option'. :D

Theoretical
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Re: Tail Risk Protection

Post by Theoretical » Mon Sep 24, 2018 10:38 pm

There's also this Alpha Architect article by a guest poster on the subject: https://alphaarchitect.com/2018/04/05/t ... anagement/
Last edited by Theoretical on Tue Sep 25, 2018 10:08 pm, edited 2 times in total.

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unclescrooge
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Re: Help Understanding Mark Spitznagel And Tail-risk Hedging?

Post by unclescrooge » Mon Sep 24, 2018 10:53 pm

It's mentioned in the article.

You buy deep out of the money puts for pennies. If the market crashes you make dollars on your pennies. But since the market goes up 2/3rds of the time, 2/3rds of the time you lose money.

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Re: Tail Risk Protection

Post by LadyGeek » Tue Sep 25, 2018 3:44 pm

I merged bluerafters' thread into the relevant discussion.
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ThrustVectoring
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Re: Tail Risk Protection

Post by ThrustVectoring » Wed Sep 26, 2018 12:11 pm

galeno wrote:
Thu Sep 20, 2018 7:40 pm
The Boglehead way of tail risk protection:

Rick Ferri uses a lower % of more volatile equities (small cap value equity fund/ETF) and more bonds vs a higher % of less volatile equities (TSM) and less bonds (TBM).

E.g. 40% SCV + 60% TBM vs 60% TSM + 40% TBM.
That's the opposite of what I'd expect to work best. High risk/return assets in general tend to be overpriced due to investors with limited access to leverage seeking extra returns. If you're already at a point where you want less risk than 100% total stock market, you're likely better off adding in a minimum volatility fund instead of doing a small-cap-value / treasury barbell strategy.

Theoretical
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Re: Tail Risk Protection

Post by Theoretical » Wed Sep 26, 2018 12:32 pm

It’s a Swedroe approach, not a Ferri one.

One justification is that small Value stocks tend to have a lot of internal leverage, and if you plot them vs the 500 at 1.5x -50% cash, you get similar results overall both in return and standard deviation.

hdas
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Re: Tail Risk Protection

Post by hdas » Thu Sep 27, 2018 7:30 pm

Here's another firm that offers similar service
LongTail Alpha is named after its strategy that "sustained portfolio performance comes from expecting the unexpected, and positioning portfolios to earn yield while maintaining convexity," according to a statement he issued. Bhansali said he is initially funding the firm himself. He earned a Ph.D. in theoretical physics from Harvard University in 1992 after receiving bachelor's and master's degrees in physics at the California Institute of Technology. He […] worked at Pimco for 16 years
He wrote an interesting 'light' paper, here

And a more technical paper Tail-Risk Management for Retirement Investments
Vineer Bhansali

Abstract
One of the insights of behavioral finance is the tendency for small investors to overreact to market swings. Even a well-structured portfolio may be vulnerable to panic selling in a downturn. The article explains how a policy of tail-risk hedging could deter such behavior by putting a floor on drops in the portfolio. Instead of maintaining an overly conservative stance and an unnecessarily low share of equities, investors could hedge their portfolios by relying on options, which have become a much more feasible tool for the small investor in recent years. The article discusses the relationship between the time to retirement and the need to hedge. Investors nearing retirement have to adopt a more defensive position or hedge explicitly, but younger investors can be more aggressive and buy options with lower strike prices.

garlandwhizzer
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Re: Tail Risk Protection

Post by garlandwhizzer » Fri Sep 28, 2018 9:15 pm

Quotes from the article in Alpha Architect by Aaron Brask on strategies to achieve tail risk protection.
TRH strategies are very complex and will often end up with polarized results. As highlighted in the disclaimer above, it is important to understand these strategies are speculative in nature.
Accordingly, I believe it is important for investors to understand the challenges involved with these strategies before executing them. Even then, I recommend limiting allocations to these strategies. In general, I would allocate no more than 5% of one’s overall portfolio or 10% of one’s equity allocation to TRH strategies.
Not exactly a ringing endorsement.

Garland Whizzer

Theoretical
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Re: Tail Risk Protection

Post by Theoretical » Fri Sep 28, 2018 9:22 pm

garlandwhizzer wrote:
Fri Sep 28, 2018 9:15 pm
Quotes from the article in Alpha Architect by Aaron Brask on strategies to achieve tail risk protection.
TRH strategies are very complex and will often end up with polarized results. As highlighted in the disclaimer above, it is important to understand these strategies are speculative in nature.
Accordingly, I believe it is important for investors to understand the challenges involved with these strategies before executing them. Even then, I recommend limiting allocations to these strategies. In general, I would allocate no more than 5% of one’s overall portfolio or 10% of one’s equity allocation to TRH strategies.
Not exactly a ringing endorsement.

Garland Whizzer
Well, to be fair the kind of TRH he's describing has a significant insurance premium and a downright breathtaking upside. It's a far greater diversifier in terms of effect on returns in bad times than just about anything else out there, but that's why there's a volatility risk premium that's a real beating.

long_gamma
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Re: Tail Risk Protection

Post by long_gamma » Fri Oct 12, 2018 6:34 am

hdas wrote:
Wed Aug 08, 2018 9:52 am
Hi All,
I have a very specific question: Has anybody seen evidence (real track record) that tail risk strategies work?

Context:
- The most interesting type of strategy involves using part of your portfolio to buy 'insurance' in the form of long out of the money options that would explode in value if a deep correction happens. The interesting part (see video linked) is that said insurance allows you leverage your equity portion.
- I'm really curious to see how this has performed overtime, specially considering that really bad events don't happen very often. However we do have sporadic episodes of exploding volatility (2011, Aug 2015, Feb 2018)
- One likely scenario is that when its said and done, the cost of the insurance + the manager fees erode most of the added value.

Video Explanation: https://youtu.be/LyGtiiGBEc8

Finally, here is a chart https://yhoo.it/2OQoz1b of YTD with the performance of VTI (Total Stock Market ETF), TAIL (Meb Faber Cambria product for tail protection ETF) and (HTUS - Blair Hull tactical allocation ETF). We can see that these particular implementations fail to really do well in times of stress (here comparing performance during the recent correction, not ytd)

Cheers, :greedy

Note:
Kindly abstain from unsubstantiated opinions or on liner bogle-truisms.
Artemis capital management is one of the good funds in this space based on the conversation with some friends.

I have not invested, but i find their market views and research interesting.
http://www.artemiscm.com/welcome#research

Their Vega fund started in 2012, I could find investor letter 2016 in their website. This is their track record.
Image

Personally I roll my own option backspreads (1x2 or 1x3s) which has compensated me during Feb and recent turmoils.

From my experience, It is hard to invest in these tail strategies because of the drag. One needs to be tactical about it. If you can find some kind of regime switches to trigger these tail strategies, then I find it useful.

There are several regime switches like Bloomberg risk index, HSBC RiskOnRiskOff (RORO). These are all based on combination of vol and returns of many asset classes, Liquidity index like TED spread etc. Or you can construct your own based on risk assets invested and own risk tolerences

Here is the video of Chris Cole discussing vol.
https://www.youtube.com/watch?v=ywelSxtcrKE
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