Some consultants advise skipping most protective hedge funds.
"Given the underlying risks and recent performance of tail-risk funds…we shy away from them," Rob Christian, head of Research at K2 Advisors and Franklin Templeton Solutions, said in an email. "They don't necessarily pay off during periods of increased market volatility."
Christian noted that the funds were relatively expensive and haven't performed well recently. He said his firms prefer to manage portfolios using hedge funds that can quickly increase or decrease risk.
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Some say simple diversification is better.
"Most clients feel that as long as they focus on diversification, they're OK," John Anderson, president of JPMorgan Alternative Asset Management, said. "They are looking for diversifying strategies that can provide positive returns over paying for hedges which can be costly."
Besides hedge funds, some investors use options to hedge. For example, they could buy a contract that costs pennies on the dollar that would pay off big if the stock market declines by 25 percent in one year, for example.
"Today it's particularly cheap to buy protection—those strategies could add a lot of alpha when the market corrects," Aurora's Sheperd said.
"If market patterns of recent months prevail, there may be a good opportunity to hedge at even lower costs again," added Steven Wieting, chief investment strategist for Citi Private Bank.
Wieting, whose wealthy clients have at least $25 million, said he prefers using derivatives strategies to reduce portfolio risk, not dramatically altering the mix of investments for rare events.
"When the pricing is right, it can help reduce portfolio turnover and improve long-term returns by keeping clients invested," he said.
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