Tail Risk

Mike Jones tail risk

Mike Jones

Investment Insights

Mike Jones

The white paper A Comparison of Tail Risk Protection Strategies in the U.S. Market was tailor-made for the investment advisor who takes risk seriously. While written for those in the investment industry, its findings are very relevant for all.

As the global financial crisis of 2007-08 was remarkable in its severity, one of the most powerful lessons learned was that of correlation. During this particular crisis almost all asset classes declined in value. It seems as though there was no protection from having a diversified portfolio.

To illustrate this notice in the charts* below how the correlation of varying assets get closer (not farther) during a crisis. How sad is this? Just when you need diversification the most it fails you.

tail risk

*Note: [The writers] defined a normal state as any month when the S&P 500 returned greater (more positive) than -5%, and a crisis state as any month when the S&P 500 fell -5% or worse. There were 261 total months in this test. Of those months, 234 were normal and 27 were crisis months. The left panel shows asset correlations for the normal months versus the S&P 500, while the middle panel summarizes the correlations for the crisis months. The right panel simply shows the difference between a crisis state and a normal state correlation of each asset class versus the S&P 500.

Every investor knows that on any given day he is subjected to risk in the marketplace. As diversification breaks down and returns go south, our industry has created a term to define this extreme but seldom experienced event. We affectionately call it “tail risk.” As one plots the distribution of returns overtime and forecasts expected returns in the future, it is the left tail of the distribution chart that represents such tail risk.

The white paper categorizes the four primary ways that investment firms have pioneered strategies to manage tail risk and quantifies the effectiveness of each strategy. In the simplest of terms these for strategies are: Investing in Volatility, Low Beta Investing, Trend Following (across the futures market), and Tactical Asset Allocation.

For most of my career I have tried to respect the fact that markets can go into retreat mode for a season. In fact, there have been 10 occasions since 1946 where the market has dropped more than 20% (that’s once about every 7 years):

tail risk

Source: Standard and Poor’s, Fact Set / Note: Past performance is not a guarantee of future results.

I share this information with you this month because it is precisely at this point in time that your investment manager needs to be thinking about risk and how to mitigate the effects of the next bear market.

As I look over the asset allocation and tail risk investing of most of my portfolios, I see that we employ three of the four most commonly used approaches mentioned already. Look closely and you will detect Trend Following, Tactical Asset Allocation, and Low Beta Investing in some measure.

As always, the goal is to maximize returns to the upside when they are present, knowing that we will sacrifice some profit for the complimentary goal of protecting principle when markets go south.

mike signature small

Byron R. Moore, CFP® is Managing Director / Planning Group of Argent Advisors, Inc. Mike Jones is Managing Director / Investment Group of Argent Advisors, Inc. Write to either at 500 East Reynolds Drive, Ruston, LA 71270 or call (318) 251-5800. This newsletter is available via email on a free subscription basis. You can subscribe by clicking here. Direct any questions, comments or suggestions to Byron Moore at bmoore@argentadvisors.com or to Mike Jones at mjones@argentadvisors.com.
Please remember that past performance may not be indicative of future results. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product (including the investments and/or investment strategies recommended or undertaken by Argent Advisors, Inc.), or any non-investment related content, made reference to directly or indirectly in this newsletter will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful.
Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions. The opinions of any single advisor do not necessarily reflect the opinions of Argent Advisors, Inc. Moreover, you should not assume that any discussion or information contained in this newsletter serves as the receipt of, or as a substitute for, personalized investment advice from Argent Advisors, Inc.. To the extent that a reader has any questions regarding the applicability of any specific issue discussed above to his/her individual situation, he/she is encouraged to consult with the professional advisor of his/her choosing.
Argent Advisors, Inc. is a registered investment adviser registered with the Securities and Exchange Commission. Argent Advisors, Inc. is neither a law firm nor a certified public accounting firm and no portion of the newsletter content should be construed as legal or accounting advice. Argent Advisors, Inc does not offer tax, legal or insurance advice. If you are a Argent Advisors, Inc. client, please remember to contact Argent Advisors, Inc., in writing, if there are any changes in your personal/financial situation or investment objectives for the purpose of reviewing/evaluating/revising our previous recommendations and/or services. A copy of the Argent Advisors, Inc.’s current written disclosure statement discussing our advisory services and fees is available upon request.


Argent Financial Group

Argent Financial Group (Argent) is a leading, independent, fiduciary wealth management firm. Responsible for more than $30 billion in client assets, Argent provides individuals, families, businesses and institutions with a broad range of wealth management services, including trust and estate administration, investment management, ESOPs, retirement plan consulting, funeral and cemetery trusts, charitable organization administration, oil and gas (mineral) management and other unique financial services. Headquartered in Ruston, Louisiana, Argent was formed in 1990 and traces its roots back to 1930.

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