Chasing the Elusive 'Black Swan'
NEW YORK (TheStreet) -- In only two years, we've seen global stock markets double in value and a number of "risk assets" (commodities; high yield bonds) likewise rally significantly. You'd think that investors have short-term memories and are willing to throw caution to the wind.
But lurking beneath that seeming confidence is a nagging concern that at any moment, for any reason, global equity markets are about to implode. Greece, U.S. debt, Middle East unrest, another nuclear disaster, take your pick -- it will become all too obvious after the fact.
Leave it to the investment industry to recognize this fear and to take advantage accordingly. Some money center banks are approaching clients to offer ways in which to protect against financial Armageddon. Hedge funds like Capula Investment Management and 36 South Capital are managing investor capital with this goal in mind. The financial engineers at firms like Pimco have incorporated "tail risk" management into some of their product offerings. And now comes the news that Universal Investments, which already manages $6 billion with global financial calamity in mind, will be rolling out a "black swan" ETF that any ordinary investor can access.
To be sure, none of these products have appeal without some catchy buzz words to describe the phenomena that they are protecting. "Tail risk" identifies the remote possibility that something highly improbable will occur. "Black swan" takes the tail risk concept a step further: Not only is the event highly unlikely, but it has a significant impact (such as a devastating hit to your wallet). After its impact, pundits will inevitably rationalize the event as if it could have been expected and managed properly in advance.Therein lies the rub. Since this event could have been expected and managed properly in advance, shouldn't an investor have this tail risk insurance in his/her investment portfolio? After all, that's what this is, the equivalent of earthquake or tsunami insurance.
Risk Isn't SimpleNot so fast. First of all, there's the risk that a very unpleasant event might occur, but not bad enough to trigger profits in the insurance that the tail-risk fund manager is buying on your behalf. Bear in mind that these products will likely only make money in the remote likelihood that a "tail risk" event occurs. Otherwise, they will lose money, day by day, month by month. Even if the equity market were to fall by 10%, for instance, since that is not a deep enough drop to be a "tail risk," you are very unlikely to experience anything but a loss from this type of product. The product is typically only set up to protect you from The Big One.
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