On the Lookout for Black Swans

Investors are getting attuned to the risk of market disasters. Is protection worth the cost?

- Pat Regnier

An increasingly popular sales pitch on Wall Street goes like this: If you’ve insured your home against some disaster, shouldn’t you do the same for your investment portfolio? In the case of a house or apartment, the danger would be fire, flooding, or perhaps a devastating storm. In the financial markets, it might be a spike in volatility and a rapid decline in prices that wipes out months or years of gains.

For investors of all stripes, from the most august institution to the scrappiest day trader, the current maelstrom of sustained inflation, never-ending pandemic, war, rapidly rising interest rates, swooning tech stocks, and crypto collapse—what economic historian Adam Tooze calls a poly crisis—feels like the equivalent of a Category 5 hurricane. So it’s no surprise the pitch is working. Everyone, it seems, is looking for a way to ride out the storm in one piece.

There’s nothing new about guarding against unlikely but catastrophic losses. The practice is sometimes called tail-risk hedging, a reference to the skinny tail on the far side of a bell curve distribution of outcomes, where really bad things happen. It’s also known as “black swan” investing, a riffon an argument by the writer and investor Nassim Taleb: Just as Europeans assumed there were no black swans until an explorer spotted one in Australia, investors have a habit of assuming a crisis won’t happen until one does.