Is it time for a "White Swan" fund?

"Black Swans" and Nassim Taleb are all over the news these days. Tail risk hedging is all the rage after the fund group loosely associated with Taleb, Black Swan Protection Protocol, had fantastical returns in October (65% to 115% if you can't read the article). Black Swan's are so hot that even mutual funds are advertising their tail risk hedging programs as a main selling point. While there might not be anything wrong with Mohamed El-Erian's Fund, retail getting involved is often a sign of a crowded trade. Looking at Mutual Fund and ETF launches, from Tech, to Alternative Energy, to Global Water, timing of such things is rarely correct. While it could easily be argued that tail risk hedging is an essential part of risk management. To a great degree, although less than reported, risk and return are correlated. You may want to be taking on tail risk in your investments.

Providing downside insurance to investors has actually been more profitable than investing directly in the stock market over recent years. An example this is the performance of the CBOE Put Write index. The put write index has outperformed the S&P since 1986 with less volatility. This points to the fact that insuring risk is a large source of returns and one ought be wary of any program hedging such risks costing too much. Taleb's first fund, had significant issues with poor performance after the "black swan" appeared. It was eventually rolled up. Andrew Lo's (2001) hypothetical Captial Decimation Partners returned an impressive 46% annualized with 1/6th the down months from 1992-1999 as a levered tail risk insurance provider (the strategy is easily replicated by any investor and requires no borrowing). They were insuring a larger portion of the tail than many tail risk insurance programs, and obviously that amout of leverage can lead to catastrophic losses (hence Lo's title for his idea).

So what might a "White Swan" fund do? It would bet on expected outcomes, and insure against the most unlikely events that people seem so fearful of. The unlikely events it would sell hedges against? The stock averages falling dramatically and fast over extended periods, US Treasuries rising dramatically in value, deflation. It seems hyper-inflation and deflation are on the mind of Taleb. While both seem unlikely, deflation would be much more "unexpected." I am guessing Taleb may be graying up his swan a bit, and mostly betting on (non-hyper) inflation. And deflation, come on? Or maybe he is just looking to repeat his mistakes.

The question is, when everyone is lining up for insurance, should you get in the insurance business? Seems like an idea worth considering.