Understanding Risk and Tail Risk Hedging

Risk is multi-faceted and varies from investor to investor. It encompasses volatility, underperforming benchmarks, permanent drawdown risk, and more. Many investors rely on simplistic risk metrics like volatility, but these metrics often overlook important aspects of risk. To effectively manage risk, investors should consider the full probability distribution of outcomes, taking into account their specific asset portfolio. By understanding the potential bad outcomes and their likelihood, investors can determine whether they have too much, too little, or just the right amount of risk in their portfolio. Tail risk hedging is a strategy that helps protect against extreme events. While there is a cost associated with hedging, investors can view it as an investment in long-term performance. By systematically hedging against tail risk, investors can stay invested during market downturns and potentially enhance risk-adjusted returns over time.