: Fenix Investors

Tail-risk hedging programs are similar to life insurance. With tail hedges, like any insurance policy, investors pay a small amount each year — a sunk cost — for a large potential payout if the event that is being insured against occurs. This was the crux of the problem at CalPERS, according to sources.
There was a lack of understanding of that cost and thinking of it as a management fee of sorts. CalPERS “benchmarked” the tail-hedge program to the generic benchmark for the fund itself. It did not have a customized benchmark, so the 5 basis points just became another cost for CalPERS.
For example, Universa recommends a hypothetical portfolio of a 3.33 percent allocation to its tail-risk product, coupled with a 96.67 percent position to the Standard & Poor’s 500 stock index, a proxy the firm uses for the systematic risk being mitigated.
According to one source, CalPERS’ tail-hedge program “may have been swept up in a purge of many inefficient active manager programs. But the program was never meant to be under the mandate for these other programs. By design, it loses a little bit of money during good times with a huge benefit during a severe drawdown in equities.”