Hedge Survival: Strategies for Navigating Market Crises

Investors are re-evaluating the effectiveness and sustainability of "tail hedge" strategies, designed to protect portfolios against extreme market downturns. In 2018, a year marked by significant volatility across most asset classes, the Eurekahedge Tail Risk Index declined by 6%, while its counterpart, the Eurekahedge Long Volatility Index, managed only a 1% gain. This performance occurred despite 2018 being the most volatile year for equities since 2011.

The recent market reversals in 2019 have further complicated the picture, with some tail hedges losing as much as they gained in the previous quarter. While this performance rebound is understandable given market recoveries, it intensifies questions about the long-term viability of these hedging approaches and the optimal timing for realizing profits. The cost of implementing such protection strategies remains a significant factor, with ongoing expenses potentially eroding returns.

Man Group PLC highlights that the high cost of owning protection over time is a persistent challenge. Investors seeking inexpensive hedges may end up with strategies that fail during sharp market corrections. The company suggests that while investors might be tempted to manage hedges themselves due to fees, relying on experienced asset managers is often more prudent. However, the focus should be on achieving the right trade-off between cost and efficacy, tailored to specific portfolio risks rather than generic solutions.

While many tail hedge strategies have historically underperformed since the 2009 financial crisis, Man Group points out that their true value lies in specific investment objectives. For instance, if the aim is to maintain equity exposure during volatile periods, the cost of hedging might be justified by the ability to preserve potential upside. Properly designed hedges can also reduce reliance on traditional diversifiers like bonds, offering a more resilient portfolio structure.