Tail Risk Hedging

Sal Abbasi:
I'm looking forward to explaining a little of our strategy to your listeners.

EMS:
Absolutely. So to kick off the conversation, I'd love to hear from both of you about the firm and how you got to where you are today.

KS:
Yeah, so we've run a tail risk strategy that is focused on equity derivatives. So our goal is really to return large return for investors during market crashes while being flat in years where there is no sort of market crash. So this is really geared towards being a defensive alternative. We use a lot of intraday, short-term strategies that generate alpha to offset that sort of premium that is paid to really hedge a portfolio. So we do this while being long volatility across the portfolio. So for investors, this ends up being a cleaner way to hedge a portfolio that is comprised of stocks and a bunch of other alternatives.

SA:
We believe strongly in the concept of insuring against market crashes. There's so many investors out there without protection on their most valuable asset, which is their market portfolio. So you would not buy a house and not have insurance on it. And so why would you risk financial ruin due to the whims of the markets?

EMS:
So Kris and Sal, given your focus on volatility arbitrage via tail risk, I wanted to hear your overall outlook for this space.

SA:
The interesting thing about tail options is that people rush into them at exactly the wrong times. So before the Covid crash in 2020, tail options were cheap. I personally did very well on my tail options in the Covid crash, and some of them went up 50 times. But after Covid, everybody started buying large amounts of tail options and they became expensive. So in 2022, as the markets went down, people were hedged and it was a orderly decline. Orderly declines are not common. Usually markets rise slowly and crash hard. But since there were no large fall spikes in 2022, tail options did not perform. The narrative is that tail options don't work, but... And tail options have been cheap ever since that time. So which indicates that people are not hedged again. So the next crash should result in large market panic again.

KS:
Yeah. January 2020 was the time period that was notorious for short volatility strategies. So you had many institutions that were short variance swaps and all different types of volatility products to generate yield. This is one of the real reasons as to why the crash during March of 2020 was so extreme. There was this sort of massive unwinding of these positions. And as Sal alluded to, when 2022 came, there was not a massive spike in volatility. However, what we did see is more people entered back into the short volatility space. So that has been a strategy that has been working quite well.

Morgan Stanley actually put out a chart a few weeks ago on the outstanding net notional vega. And for listeners that don't really have an understanding as to what this is, this gives us an idea as to just how much exposure is being shorted from a volatility standpoint across the street. And it's a pretty scary thought to think that more people are short volatility now as opposed to January of 2020. It's almost like this behavioral cycle that happens over and over and over again. So very interesting to see the space rebound and react so fast in this short four to five year cycle.

EMS:
And more specifically, Sal and Kris, where do you see some of the greatest opportunities in this space and why?

SA:
There's so many advisors out there, Elana, that were recommending a mix of stocks and bonds to investors. And bonds were positively correlated with equities during the last crash. And if you have a 70/30 portfolio, it has a big drive in performance during years when equities are rising. So we believe it's a matter of educating investors that deploying 95% capital to the markets and 5% to tail risk is a much better strategy in good times and bad.

KS:
Yeah. To add to what Sal said, it is also critical that the tail risk strategy does not bleed away capital during the good years. And on the protection side, there is nothing like generating cash when everyone else is panicking. It gives you an opportunity to buy assets at fire sale prices, and you get a peace of mind that your savings and your lifestyle is not going to be at risk due to the randomness of the market. It's a security, so.

EMS:
On the other hand, Kris and Sal, what are some of the greatest challenges in this space and why?

KS:
Yeah, running a fast-growing firm is always challenging. Apart from trading, we work on building new strategies, backtesting them. We also have to work all in sales and marketing and investors relations at the same time. In a business like this, you're wearing multiple hats, especially with a smaller team, but it's pretty rewarding and exciting work. I look forward to being in the office. Honestly, I don't think anybody at the team considers this work. I don't think anybody thinks that this is work. I think that it's a team of individuals that has a goal in mind, and we wake up every single day and we go to sleep every single day with that sort of goal in mind. We're constantly chatting even on weekends. So it's a challenge, but it's extremely rewarding, and I think we all really enjoy it.

SA:
So I'm personally very proud of our team and the way we've divided up our responsibilities. Apart from Kris and I, we have a brilliant quant researcher, Paul. We have a great junior trader, Matt, and we have two other partners. Will helps on all aspects of the firm, especially with trading strategies, and Mike helps with technology and operations.

EMS:
Sal and Kris, to shift gears a little bit, I wanted to talk about ESG and DEI, which are top of mind for the alternative investment industry, and I wanted to see how your firm is addressing these two important topics.

SA:
Well, obviously Kris is African American, and Kris actually grew up in a pretty tough neighborhood. So this has always emphasized to the rest of us how his goal is to help the people he grew up with. So when you give a boost to people who have never had the advantages of mentorship and networks that so many of us take for granted, we really do believe it helps lift whole communities out of poverty because they have role models then to follow, right. So I recently paid, I personally paid for an elementary school to be built in the port town of Pakistan, and my goal at the Ambrus is to use the money to open ten sort of schools like this.

KS:
Yeah. The way how I see it based on my background is that an education, especially in this country, is such a crucial thing. It's the driver to systemic change. But there can't just be money that's just tossed at it, there has to be a handholding and a real active sort of engagement, a real true outreach. So I actually tie about 10% of my income every single year. Our third partner, Will, works with Sonoma State Foundation, which helps boys who grew up without a father in New Orleans. We are very active on this front when it comes to low-income housing areas, church community outreaches. The nature of what we do from a trading standpoint is very different. So we aren't going to be investing in derivatives that are ESG based, but the profits that we do make go back into helping fund these sort of core values that we believe in.

EMS:
Sal and Kris, we've covered a lot of great ground today, so I wanted to see what your future plans are for the firm.

KS:
Yeah, we're growing so fast and we're always busy, but I think in terms of future plans, it's to continue to grow the AUM and trade the portfolio well. We think that we have something very special. It's very rare to come across a tail risk strategy that is designed the way how ours is. And we like to joke and we think about it as free insurance, right. Imagine your home insurer paid you to also protect your home. You would say, "Wow, this is an amazing thing." So hopefully, you just spread that message a little bit more and continue to grow the business as a whole.

SA:
There is such a huge need out there. We feel like so many investors are poorly served with just old ideas, old portfolio management techniques, and we think that this is a really valuable product that can help a lot of people with their portfolios.

EMS:
Well, Kris and Sal, I wanted to thank you both for sharing your perspective with our listeners.

KS:
Yeah. Thank you so much. We really appreciate you guys for having us on.

SA:
It's always a pleasure talking to you, Elana.

EMS:
And thank you for listening to the EisnerAmper Podcast Series. Visit eisneramper.com for more information on this and a host of other topics. And join us for our next EisnerAmper Podcast when we get down to business.

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