Mind the tails! Anticipatory risk management for target-date strategies

Joseph Simonian

Journal of Risk

Abstract: ABSTRACT The recent financial crisis has exposed the vulnerability of many target-date funds to unforeseen systemic shocks (sometimes referred to as "fat-tail events"). The negative impact of rare but catastrophic market downturns has been felt particularly strongly by investors near retirement age as many of them have been forced to delay or alter their retirement plans. This paper will describe the main tenets of a risk management strategy that is founded on an investment-based approach to tail risk hedging. We argue that such an approach is particularly suited to target-date strategies given the priority that plans and plan participants place on downside protection. We also argue that tail risk within the context of asset allocation is best modeled and managed using multifactor models due to their ability to accommodate the various types of risk that portfolios may be exposed to.

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