Tail Hedging And Crisis Alpha

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During their recent interview with Tobias, Jason Buck and Taylor Pearson of The Mutiny Fund discussed Tail Hedging And Crisis Alpha. Here’s an excerpt from the interview:

Jason: Yeah, the idea being that spoonful of sugar. For decades, Taleb and Spitz Nagel, and all these guys have been saying, “You should just eat the bleed of tail risk.” And we just felt behaviorally people aren’t willing to do that. We believe in ensemble approaches. So, we think through the ensemble approach, we can try to maintain a flat or slightly positive return during a risk on cycle, that will make sure people hold it on their books. It’s really just that spoonful of sugar help the medicine go down to make sure you maintain that tail risk protection for the blow-ups. We want to try to use an ensemble rebalancing premium approach to try to maintain a flat to slightly positive carry instead of that negative carry, and then your CalPERS and you get rid of it right before the blow-up.

Tobias: [laughs] They always seem– it’s funny, the two challenges that I can see with tail risk is, the bleed over a long period of time makes it hard for folks to hold. And then on top of that, really what they should be doing as the short volatility side of it, whoever that’s constructed as that’s going up, they really should be rebalancing away from that and increasing their allocation to long volatility. But that’s hard, because they’re looking at that side, losing all the time. That’s a sickening thought, particularly when we’ve been through these very long periods of volatility suppression.

Then, the other challenge is when you finally get the blow-up, it needs to go the other way. You need to be able to rebalance away from that side of the book that’s working so that you can now go and buy all of these undervalued assets on the other side. It’s just hard in a lot of funds to achieve that because the lock-up and so on.

Taylor: To going back to the goal thing at some point, I hate the way we generally talk about is. The goal is to help investors maximize their long-term compounded wealth. That’s the goal. And from our perspective, the reason we started this was– we felt like an essential piece of being able to do that and just was really hard for noninstitutional investors to get access to these sorts of strategies. So, yeah, I think you’re right. You want the end investor to look at the whole portfolio. It’s like this is improving the long-term compounded growth of your portfolio. Yeah, we’ve had to be conscious to some extent of– as people are going to look at as a line item, whether or not they should, and they probably should to some extent, but by having it, by trying to bundle it up, and look at this in the context of the broader portfolio, it’s a little more palatable.

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