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Estlander Awaiting the Black Swan

Report: Alternative Fixed Income

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Stockholm (HedgeNordic) – Finnish systematic asset manager Estlander & Partners has been in the business of providing so-called “crisis alpha” for decades through one of the Nordic region’s longest-running trend-following vehicles. Since late 2021, Estlander & Partners has been managing a separate vehicle specifically designed for “black swan” events. Estlander & Partners’ “tail hedge” vehicle aims to deliver significant returns, with triple-digit return potential, during extreme market crashes, such as those seen during the Covid-19 crash or the global financial crisis of 2007-2008.

Since 1928, the S&P 500 has experienced 56 market corrections of over ten percent. “This essentially means that we have these cyclical events fairly often, about once every 20 months,” says Walter Estlander, Managing Director at Estlander & Partners Investment. “Tail events are far more common than we think, and markets have proven not to follow a normal distribution,” he elaborates. “Despite this significant flaw, markets are still assumed to follow a normal distribution,” according to Estlander, leading to tail risks being mispriced due to the presence of ‘fat tails’ in the real distribution.

“Tail events are far more common than we think, and markets have proven not to follow a normal distribution. Despite this significant flaw, markets are still assumed to follow a normal distribution.”

Walter Estlander, Managing Director at Estlander & Partners Investment.

After studying the occurrence of tail events in detail, the team at Estlander & Partners concluded that the best way to assist investors is by protecting against significant market moves or black swans that trigger losses exceeding 30 percent. “These hurt investors the most,” notes Walter Estlander.

Historically, there have been 13 such black swan events since 1928, with the most recent being the COVID-19-induced market crash in the first quarter of 2020. “By including a tail risk hedge component, investors can carry more risk in other investments without increasing tail risk, hence earn more on their portfolios,” argues Walter Estlander. ”In addition, compounded returns are enhanced when drawdowns are reduced,” he continues. “Bottom line is more compounded return and more peace of mind – a very desirable combination.”

“Bottom line is more compounded return and more peace of mind – a very desirable combination.”

Walter Estlander, Managing Director at Estlander & Partners Investment.

Institutional investors often avoid adding tail risk protection to their portfolios for several reasons: it is expensive, difficult to time, and can erode returns until a black swan event occurs. Estlander & Partners Tailhedge Alternative Investment Fund (AIF) has been designed to maintain cost-efficient exposure to out-of-the-money equity put options in a systematic way that pays off in an equity crisis. “We believe we have managed to solve the issues of expensiveness and timing, thus found the holy grail of investing in tail risk protection,” says Estlander. “Hence, we also have this component in our multi-strategy fund Estlander & Partners Freedom AIF.”

“We believe we have managed to solve the issues of expensiveness and timing, thus found the holy grail of investing in tail risk protection.”

Walter Estlander, Managing Director at Estlander & Partners Investment.

Though not yet tested by a real black swan event, the strategy behind Estlander & Partners Tailhedge aims to generate significant returns during such occurrences while maintaining a zero return target or a “low bleed” of returns in the interim. While Estlander & Partners Alpha Trend strategy, the long-running trend-following fund, provided crisis alpha in 2022 with a 10.2 percent gain, the Tailhedge strategy did not activate its protection mechanisms as US equities, as measured by the S&P 500, had a maximum drawdown of 25 percent and ended the year with an 18 percent loss. Estlander & Partners Tailhedge, therefore, is patiently awaiting the next black swan event to deliver significant returns.

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Eugeniu Guzun
Eugeniu Guzun
Eugeniu Guzun serves as a data analyst responsible for maintaining and gatekeeping the Nordic Hedge Index, and as a journalist covering the Nordic hedge fund industry for HedgeNordic. Eugeniu completed his Master’s degree at the Stockholm School of Economics in 2018. Write to Eugeniu Guzun at eugene@hedgenordic.com

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