Lessons from 15 Years of Managing Tail Risk

Swan Risk Management was founded in 2010, in the aftermath of the worst financial crisis in generations. For fifteen years since, we've helped investors navigate uncertainty—the European debt crisis, the taper tantrum, COVID-19, rapid rate hikes, and countless smaller dislocations that tested portfolio resilience.

Along the way, we've learned lessons about tail risk that only experience can teach. Some confirmed what we expected. Others surprised us. All have shaped how we think about protecting portfolios from extreme events.

Lesson 1: Tail Events Are More Common Than Models Suggest

Traditional risk models assume returns follow normal distributions—the familiar bell curve. Under this assumption, events like the 2008 crisis should occur once every several thousand years. Obviously, they happen more frequently.

Real market returns have "fat tails"—extreme events are more common than normal distributions predict. This isn't news to practitioners, but the implications are underappreciated:

• Value-at-Risk and similar measures systematically underestimate extreme loss potential
• Historical data may not capture the full range of possible outcomes
• Protection designed for "normal" volatility may be insufficient for actual crises

The practical implication: design protection for worse scenarios than history suggests. Assume that the next crisis may be worse than any you've seen.

Lesson 2: Correlation Spikes When It Matters Most

Diversification is supposed to protect portfolios—when some assets fall, others should rise, smoothing overall returns. This works in normal markets. It fails in crises.

During extreme stress, correlations spike across nearly all risk assets. Stocks, credit, real estate, commodities—they all fall together. The diversification you thought you had evaporates precisely when you need it most.

This happens because crises trigger forced selling. Leveraged investors face margin calls. Redemptions hit funds. Liquidity evaporates. Everyone tries to sell everything at once, and correlations converge toward one.

The implication: don't rely on correlation-based diversification for tail protection. You need assets that are explicitly designed to rise in crises, not just assets that have been uncorrelated historically.

Lesson 3: Liquidity Disappears When You Need It

In normal markets, you can generally trade what you want at prices close to recent levels. In crises, liquidity vanishes. Bid-ask spreads widen. Market depth disappears. Prices gap.

We've seen supposedly liquid markets become essentially untradable during acute stress. We've seen "liquid" alternative investments gate redemptions. We've seen prime brokers pull credit at the worst possible moments.

This creates a vicious cycle: falling prices trigger selling, selling depletes liquidity, poor liquidity causes prices to fall further. Investors who need to sell are trapped.

The lesson: maintain genuine liquidity reserves. Don't count illiquid investments as available capital. Build buffers that account for the possibility that you'll face costs far worse than normal trading suggests.

Lesson 4: Protection Has Costs, But They're Worth Paying

Tail risk protection isn't free. Options decay over time. Hedging strategies incur ongoing costs. Capital allocated to protection earns lower returns than capital deployed for growth.

During bull markets, this cost feels painful. You're paying for insurance against events that aren't happening. Unhedged portfolios outperform. The temptation to reduce or eliminate protection is strong.

But the math is clear: the cost of protection over time is typically far less than the cost of being unprotected during a single severe crisis. A 40% drawdown requires a 67% gain just to break even. Avoiding that drawdown—or even reducing it significantly—is enormously valuable.

We've learned to frame protection costs as insurance premiums. No one expects insurance to "pay off" every year. They expect it to be there when catastrophe strikes.

Lesson 5: Positioning Before the Crisis Is Everything

Once a crisis begins, options narrow rapidly. Hedges become expensive or unavailable. Liquidity for repositioning evaporates. Markets that were orderly become chaotic.

The time to build protection is before it's needed—when markets are calm, volatility is low, and hedging is cheap. This requires acting when danger feels distant, which is psychologically difficult.

We've seen investors repeatedly make the same mistake: they wait until stress is visible, then scramble to protect. By then, the cost of protection has spiked, and execution is difficult. The best opportunities to hedge are behind them.

This is why systematic, ongoing risk management matters more than reactive crisis response. The decisions made in calm periods determine outcomes during storms.

Lesson 6: Every Crisis Is Different (But Also the Same)

The 2008 financial crisis was about housing and leverage. The 2020 COVID crisis was about a pandemic-induced shutdown. The 2022 drawdown was about inflation and rate hikes. Each had unique causes and characteristics.

Yet certain patterns recur:

• Correlations spike
• Liquidity disappears
• Leverage unwinds violently
• Sentiment swings to extremes
• Opportunities emerge for those with capital

The specific trigger matters less than you might think. The mechanics of crisis—forced selling, liquidity withdrawal, panic—are remarkably consistent. Protection strategies should address these mechanics rather than trying to predict specific scenarios.

Lesson 7: Recovery Happens Faster Than Expected

In the depths of crisis, it's hard to imagine recovery. Panic is contagious. Headlines are terrifying. Markets feel broken.

Yet markets consistently recover faster than crisis-mode thinking suggests. The March 2020 crash was followed by one of the fastest recoveries in history. The 2008-2009 crisis, while severe, gave way to a decade-long bull market.

This doesn't mean crises aren't dangerous—they are. But investors who sell everything at the bottom, or who remain paralyzed during recovery, pay an enormous opportunity cost. Protection should enable participation in recovery, not just survival of the crash.

Lesson 8: Psychology Matters as Much as Analytics

Risk management isn't purely a quantitative exercise. Human behavior—fear, greed, panic, complacency—shapes markets and individual decisions.

We've seen investors with excellent analytical frameworks make terrible decisions because emotion overrode analysis. We've seen carefully constructed hedges abandoned at exactly the wrong moment because the cost "felt" too high.

Effective tail risk management must account for psychology:

• Strategies should be designed to be maintainable under stress
• Decision processes should reduce the impact of emotional reactions
• Pre-commitment to plans made in calm periods should be explicit
• Frameworks for interpreting crisis information should be established beforehand

Putting It All Together

Fifteen years of managing tail risk have taught us that protection is possible, but it requires discipline, patience, and humility. The investors who navigate crises best are those who:

• Accept that extreme events will occur, even if timing is unpredictable
• Build protection before it's needed, when costs are manageable
• Maintain genuine liquidity for both defense and opportunity
• Don't rely solely on historical correlations for diversification
• Have explicit plans for crisis scenarios, developed during calm periods
• Understand their own psychology and build systems to manage it

None of this eliminates risk. Markets will always surprise us. But systematic attention to tail risk dramatically improves the odds of not just surviving crises, but emerging from them in a position of strength.

That's been our mission for fifteen years. It remains our mission today.