An increasingly popular sales pitch on Wall Street goes like this: If you’ve insured your home against some disaster, or even a total loss, shouldn’t you do the same for your investment portfolio? In the case of a house or apartment, the danger would be fire, flooding, or perhaps a devastating storm. In the financial markets, it might be a sudden spike in volatility and a rapid decline in prices that wipes out months if not years of gains.
For investors of all stripes, from the most august institution to the scrappiest day trader, the current maelstrom of sustained inflation, never-ending pandemic, war, rapidly rising interest rates, swooning tech stocks, and crypto collapse—what economic historian Adam Tooze calls a polycrisis—feels like the equivalent of a Category 5 hurricane. So it’s no surprise the pitch is working. Everyone, it seems, is looking for a way to ride out the storm in one piece.
There’s nothing new about guarding against unlikely but catastrophic losses. The practice is sometimes called tail-risk hedging, a reference to the skinny tail on the far side of a bell curve distribution of outcomes, where really bad things happen. It’s also known as “black swan” investing, a riff on an argument by the writer and investor Nassim Taleb: Just as Europeans assumed there were no black swans until an explorer spotted one in Australia, investors have a habit of assuming catastrophes won’t happen until one does. Black swan funds are designed to make money when things go badly in ways no one saw coming.
