Sting in the tail

LEADER

When former US defence secretary Donald Rumsfeld baffled the world by coining the phrase ‘unknown unknowns' he probably did not realise he was neatly describing what asset managers call ‘tail risk'.

It is what keeps hedge fund managers up at night, the events they never even knew could befall them – financial systems imploding, strong sovereigns defaulting, hyperinflation. As David Rogers, CEO of hedge fund JD Capital Management, puts it: “Protecting against it is not just about setting risk parameters based on historical standard deviations, it is about contemplating the worst possible scenario.” Traditional managers mention tail risk less, perhaps because systemic events take them down more or less in unison, so no damage is done on a relative basis at least. However, as abs...