'Black Swan' Investors Lose Big as Stocks Thrive

Black swan funds, designed to hedge against major market declines, have suffered huge losses as the stock market has soared since the financial crisis, the Wall Street Journal reports. On average, their value has fallen by 6.3% for the year-to-date through July, and they lost money in four of the previous five years, per data from eVestment cited by the Journal. Indeed, after hitting peak performance in September 2011, these funds have fallen by about 55%, according to data from CBOE Eurekahedge reported by the Journal.

That's a big change from seismic events such as the 2001 dot-com bubble and the 2008 financial crisis, during which the S&P 500 Index (SPX) and the Dow Jones Industrial Average (DJIA​) plunged and black swan funds reaped rich profits.

Also known as tail risk funds, black swan funds seek to reap enormous profits from a sharp, severe downward move in the markets. They purchase put options to provide downside protection, as well as gold and other safe-haven assets that usually rally when other financial assets collapse in value, the Journal says in its September 5 story.

Swan Songs

Universa Investments LP is a black swan fund that posted returns of over 100% during the financial crisis in 2008, the Journal says. Today, its founder, Mark Spitznagel, tells the Journal, "I don't see anyone out there doing what I do." He notes that going through long periods of losses during calm or rising markets tests the patience of fund managers and investors alike, but that patience should be rewarded when the next Black Monday happens. The Journal went on to mention several black swan funds that either are floundering, or that have been shut down.

The Man Group, a London-based alternative investment management business, has seen its AHL Tail Protect Fund lose 45% of its value since it 2009 launch, according to Man Group data reported by the Journal. The $3.7 billion Tail Risk Fund from Capula Investment Management, another London-based hedge fund giant with over $10 billion in total assets under management, is down 6.7% this year, per an investor letter obtained by the Journal. The Capula fund gained 11% in 2011, lost 14% in 2012, and fell in three of the next four years, per the Journal. Neither Man Group nor Capula would comment to the Journal.

Paris-based insurance group AXA SA (AXAHY) shut down its own black swan fund several years ago, per the Journal, as has Swiss-based Unigestion SA. However, Unigestion continues to utilize various hedging strategies such as put options and currency trades.

While Black swan funds' performance has lagged during an eight-year bull market of dramatic stock gains, equities are showing signs of age. Also, concerns about the nuclear threat from North Korea, Hurricane Harvey and other storms helped push down stocks sharply this week. Many experts say a recession and bear market aren't far off, two developments that might benefit black swan investors.

Bad Timing

But for the moment, these bearish, tail-risk bets on the markets have turned sour as central banks continue to flood them with liquidity and as the global economy grew. Meanwhile, the CBOE Volatility Index (VIX), commonly used as an indicator of uncertainty and fear among investors, fell to its lowest intraday level ever in July and remains near historic lows. Moreover, key equity market indicators such as the S&P 500 have set one record after record after beginning an upward climb in early 2009, while a bull run in bonds continues unabated.

For the long term, taking out insurance against market volatility is a losing strategy, the Journal says, pointing to "a raft of academic papers and market analysis." The problem is that any form of insurance costs money, and that, on average, those selling insurance will profit from those buying it.


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