Do investors potentially give up returns when implementing tail risk strategies?
Bhansali: Yes, they do give up returns in the short term because there’s a cost to implementing hedges. But, over the long term, thinking of this as “giving up returns” is short-sighted, because these hedges could end up covering their cost by many multiples during a market crisis. So, you give up returns in the short term, but, over the long term, you have a strategy that may potentially result in excess positive returns. In the view of PIMCO, having tail risk strategies is really a potential alpha-adding strategy for a long-term investor. Q: If tail risks are hard to predict, how can investors identify what they should be hedging? Bhansali: It is very hard to identify in advance what – and how severe – the tail risks will be. But a key characteristic of all tails is that they spur increased correlation between asset classes and deleveraging, as good assets get sold with bad assets. So, we find that nearly all tail risks that matter for typical investment portfolios are systemic risks
