What Is The 'Tail Hedge'? Read 'Black Swan’ Author's Recommendation For Investors Amid 'Huge Amount Of Uncertainty’

Famed investor Nassim Taleb has advised investors to use a "tail hedge" to protect their stock portfolios against systemic risks, or not risk investing at all given the prevailing uncertainty in the global economy. In an interview with CNBC on Friday (June 26), the author of ‘Black Swan: The Impact of the Highly Improbable’ said, “If you don’t have a tail hedge, I suggest not being in the market (as) we’re facing a huge amount of uncertainty.”

A tail hedge is a hedge against tail risk, where the latter term defines events that have a low probability of occurrence. A tail risk and Black Swan are closely related terms, where Black Swan is an ‘unpredictable event that is beyond what is normally expected of a situation and has potentially severe consequences,’ as defined by Investopedia. The main features of such events are that they occur rarely but have a very severe impact.

The term Black Swan can be used to describe the current global economic crisis. For one, it is rare, a man-made crisis of rarely witnessed intensity, and severe impact as its magnitude cannot be quantified or measured owing to the spread of the coronavirus pandemic and its ripple-down effects.

Mark Spitznagel, founder and owner of Universa Investments, a hedge fund management firm based in the U.S., is known to be the pioneer of ‘tail-hedging’ or ‘Black Swan’ investing.

Taleb, who is also adviser at Universa Investments, spoke of impact of the U.S. Federal Reserve’s relief program on the economy. He said this involved the incessant printing of money with the simultaneous lowering of interest rates to near-zero levels and has resulted in the negation of the value of bonds. “Bonds practically have no upside structurally,” he said, adding investors could no longer count on these financial instruments to hedge their portfolios, further emphasizing on the importance of investing in the stock market with a tail hedge to counter downside risk.

“If you don’t have a tail hedge, I suggest not being in the market (as) we’re facing a huge amount of uncertainty,” Taleb said. “And COVID-19 seems to be there even if the pandemic … dies down, you will still have people cautious enough that it will impact a lot of industries.”

However, some rubbish Taleb's theory of 'tail hedging' in the face of a 'Black Swan' event. In an article carried in ‘The Christian Science Monitor’ titled ‘Here a swan, there a swan, everywhere a Black Swan,’ guest blogger Joshua Brown drew attention to the subprime crisis in the U.S. over a decade ago. He wrote, “The Black Swan event of 2007-2009 has shown people that no amount of diversification of sectors or asset classes will matter in a crisis. During a Black Swan event, (a crisis) arrives and quickly shreds through everyone's models and assumptions.”