Tail Risk Hedging and Trend Following: A Combined Framework

Investing in equities offers strong growth potential, but a key drawback is exposure to periodic drawdowns, which many investors find psychologically difficult to endure. To address this, some have proposed tail risk hedging strategies. However, portfolio managers are often reluctant to adopt them due to high carry costs, and researchers continue to debate their effectiveness.

Reference [1] implemented a particular tail risk hedging strategy and overlaid it on a trend-following approach, referred to as the Portable Alpha Portfolio.

The Portable Alpha Portfolio consists of two components: 100% exposure to the MSCI ACWI Index as the beta source, while alpha is generated through a tail risk hedging overlay and a 50% exposure to a trend-following strategy.

• The tail hedge is constructed by systematically purchasing three tranches of 10-delta SPX put options with one year to expiration, rolled quarterly, and notionally sized.
• The trend-following component includes 79 futures contracts, with normalized returns computed over four lookback periods: 3, 6, 9, and 12 months. Positions are taken long when the lookback return is positive and short otherwise.

The authors pointed out,

This study examines the performance enhancements from applying a Portable Alpha framework to a global equity portfolio by overlaying both trend-following and tail risk hedging strategies. The Portable Alpha portfolio maintains 100% exposure to the MSCI ACWI Index as its beta source, while alpha is introduced through a tail risk hedging overlay and a 50% exposure to a trend-following strategy…

The resulting Portable Alpha portfolio generated a large, positive, and statistically significant alpha of 0.25% per month after controlling for traditional equity factors, global government bond, and commodity returns. Absolute outperformance was concentrated during periods of crisis, particularly in the first half of the sample, with more recent periods showing broadly comparable returns to ACWI. However, the Portable Alpha portfolio consistently delivered superior risk-adjusted performance across the full sample, with notable improvements in downside protection. These findings are consistent with those in Schwalbach and Auret (2023). Performance attribution confirms that the Portable Alpha portfolio effectively captured ACWI excess returns, demonstrating that convex return streams can be overlaid to enhance performance without diluting core equity exposure.

In summary, this study finds that combining tail risk hedging with trend following adds value to a long-only equity portfolio, supporting the case for incorporating tail risk hedging into portfolio management.

Let us know what you think in the comments below or in the discussion forum.

References

[1] Bruno Schwalbach & Christo Auret, Enhancing global equity returns with trend-following and tail risk hedging overlays, Investment Analysts Journal, 2025

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