36 South launches tail risk hedge fund investing in long-dated options
36 South’s new fund builds on its existing offering of tail risk and long volatility hedge funds. The fund aims to protect against black swan and less predictable events with long-dated options.
36 South Capital Advisors is launching a tail risk protection strategy which is designed to make a positive return during extreme market events.
Co-founder and chief investment officer Richard (Jerry) Haworth says extreme downside events are occurring more frequently than is priced into options.
The Black Eyrar Fund will provide tail risk protection through the use of long-dated options, which Haworth believes are the best tool for the job. “They tend to be massively overvalued or massively undervalued. When they are massively undervalued, you get the most convexity or the most bang for your buck of all the tail risk hedging instruments out there.”
The aim is to protect an investor’s portfolio against black swan (unknowable) events and grey swan (uncertain) events and make a positive return during market downturns.
Haworth believes one of the biggest potential tail risks in the market will be caused by central bank action. “Central banks piling more debt onto a very indebted financial structure leads to more financial instability in the medium to long term even though in the short term there has been a suppression of volatility. We believe volatility and the level of debt go hand in hand. Looking forward there is a greater likelihood there will be significant volatility.”
Traditionally portfolio diversification has been viewed as an effective risk management tool but this belief was shaken in 2008 when correlation between asset classes increased.
Haworth thinks diversification is the only effective protection against what he calls the first order of risk. “As soon as things get uncertain, as all the correlations go to one, diversification fails like in 2008. You need a second order of risk management techniques.” Holding a tail risk or long volatility fund is a way to protect a portfolio against such risk, he says.
Options contracts will be added to the portfolio when they are cheap, which Haworth says is the opposite of what most investors do. “With tail hedging most people put it on when the price of the hedge is so expensive it doesn’t make sense and they take it off when the hedge is cheap,” he explains.