The idea of hedging against catastrophe, otherwise known as tail risk, has become the latest rage among hedge funds, according to money managers and traders.
Three years after Nassim Nicholas Taleb popularized the idea of guarding against so-called black swan events—extremely rare but disastrous market circumstances—a small but growing number of hedge funds have opened dedicated tail-risk hedging vehicles to provide wary investors with additional insurance against calamity. (The fund Taleb advises, the Santa Monica, Calif. based Universa Investments, has been dedicated wholly to tail-risk hedging since 2007.)
Tail-risk funds buy products like credit default swaps and equity put options as down payments that will reap returns if certain markets decline far more than they would on an average day.