Time and Money: The Cost of Tail Risk
Extreme negative market events are often referred to as left tail events. Traditional investment strategies, such as long-only equity portfolios, are inherently exposed to left tail events due to their unidirectional capabilities.
Since the turn of the 21st century, markets have shown that recovering from left tail events can be challenging because any future gains will be made on a lower capital base.
What this chart shows
The chart to the right the is drawdown of the S&P/ASX 300 from 2007 until recovery. It illustrates the reality of left tail risk, and shows that an investors who’s portfolio lost the maximum of 50% needed a positive return greater than 100% just to bring the portfolio back to its starting value.
What it means for investors
Because regaining the lost portfolio value may take considerable time or assuming excess risk, investors looking to protect their portfolios and enhance long-term return potential may want to proactively guard their portfolios against left tail events, and their potentially disastrous outcomes.
Realized Drawdown of ASX 300 Accumulation Index 2005-2015