Investors seek protection from extremes

Investors are funnelling more assets to hedge funds that protect them against extreme events amid the European sovereign debt crisis and global economic recession.

Tail-risk funds aim to profit at times of rare events of low probability and extreme impact. They typically bet on dramatic moves in prices and seek to minimise their losses during times of rising or stable prices.

Among those attracting interest have been tail-risk funds run by Bennelong Asset Management, 36 South and Saba, founded by former Deutsche Bank trader Boaz Weinstein.

Their assets under management are not large by industry standards at $66m, $80m and $550m respectively, but all have risen by more than 10 per cent from a combination of performance and investor inflows in August and September, according to figures compiled by JPMorgan.

Funds run by Man Group, Capula and Universa have also seen inflows, according to the survey.

Universa is advised by Nassim Taleb, author of The Black Swan and a critic of traditional risk management by the financial industry.

These funds have seen inflows at the same time that other hedges typically used by traders, such as exchange-traded products that track the CBOE Volatility Index, or Vix, have seen sharp rises in price.

Nikolaos Panigirtzoglou, European head of global asset allocation and alternative investments at JPMorgan, said: “The normal things that people do in traditional hedges, which make money when equities go down, have become a lot more expensive”.

The price of the iPath S&P 500 Vix Short-term Futures exchange-traded note has risen 138 per cent since the beginning of August amid worries over the eurozone.

Despite the jump in volatility, the ETN has seen outflows of $1.1bn, according to IndexUniverse, which tracks fund flows. Mr Panigirtzoglou said many traders were shifting into hedge funds.

He said: “The challenge for hedge funds will be to find cheaper sources of tail-event hedges such as structured products, conditional hedges and use of longer-dated derivatives,”

Aaron Yeary, portfolio manager of Pine River’s multi-strategy fund, warned that investors should avoid taking unusual risks in their attempts to hedge. Pine River has seen its tail-risk fund assets rise 14 per cent in August, the most recent figures available in JPMorgan’s data.

He said: “You get into this daisy chain of logic where it ends up that you might be buying cotton futures to hedge seismic moves in credit markets, and that is not a good way to go about things”.

“If you are getting esoteric with your hedges, those may not be very good hedges at all.”