Morningstar Advisor - April/May 2009 - (Page 54) Undiscovered Managers Investors Should Mind Their Tails By Lawrence Jones The market experiences more shocks than investors think. PIMCO’s Vineer Bhansali thinks he has a way to guard against these events. Like many great ideas, this one came together unexpectedly at a meeting between old colleagues. The story of the development of PIMCO’s tail-risk hedging strategy began as a casual chat between two highly respected scholars of finance: Vineer Bhansali and Mohamed El-Erian. Bhansali, head of PIMCO’s 14-person analytics team, was in Boston delivering a conference paper. El-Erian, who had worked at PIMCO, was president and CEO of Harvard Management Co., the firm charged with managing Harvard University’s endowment. Bhansali met up with his former colleague to discuss a novel hedging approach he was developing at PIMCO. As it turned out, El-Erian was doing something similar at Harvard. The approach, called “tail-risk hedging,” aims to protect portfolios that deploy the strategy from rare and systemic shocks. Popularly referred to as “black swans,” these events can greatly damage investor results. They are the dramatic losses that appear on the far left end—the “tail”—of the probability distribution curve of investment returns. Their chances of happening are supposed to be minute, but some in finance and economics believe that the shocks occur more frequently than commonly thought, and people are developing ways to hedge against the risks posed by these shocks. Bhansali first implemented tail-risk hedging several years ago in a hedge-fund-like strategy he was running at PIMCO for an insurance company. The client became more interested in how Bhansali was hedging away the portfolio’s tail risk than in the overall hedge fund. The 54 Morningstar Advisor April/May 2009
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