Tail Hedging I – An intro to Systematic Defensive Strategies

Government bonds used to be the unicorn in a multi asset allocation, offering positive carry with negative correlation to equity markets. With the current low rate environment and inflationary pressures, both of these qualities are now called into question. Some alternative strategies such as CTA or Macro strategies are well known and have been used for decades by investors, to achieve diversification and mitigate downside risk during adverse periods for growth-oriented assets. In the current environment, we believe there is a need for a differentiated approach combining different strategies, in order to reduce the long-term cost and increase the success rate at the same time. We built a range of systematic strategies seeking to protect during equity drawdowns, while aiming to be as cost-efficient as possible. This includes pure option strategies (explicit protection, i.e. “tail-hedging”), strategies replicating similar profiles (such as delta-replication strategies) or systematic macro defensive strategies. We show that the outcome offers a robust protective solution, attaining a very high consistency ratio during the worst equity drawdowns, while keeping average costs close to 0% over the long run.