Tales from the Downside: Risk Reduction Strategies

Abstract

High market volatility has driven the development of investment strategies advertised to deliver reduced risk without reduced return. The “low-volatility” equity anomaly (low-risk stocks may have similar or greater returns than high-risk stocks) is best exploited by investors as part of the toolkit of a broader active strategy. “Tail risk” strategies can provide protection in extreme market events, but their persistent negative carry (ongoing cost) make them unappealing to most investors. Managed futures and global macro hedge fund strategies have desirable downside risk protection characteristics combined with positive returns and alpha for skilled investors. Investors can increase their downside protection by allocating part of their hedge fund or opportunistic asset category to managed futures and global macro strategies.

Keywords: Low volatility, equity, hedge funds, tail risk, managed futures, CTAs, global macro, hedging

JEL Classification: G00, G11, G14, G23