(Bloomberg) -- KKR & Co.’s Henry McVey is advising investors to buy “tail risk” protection against the potential for low-probability events, like the dollar losing its status as the world’s reserve currency or a sudden spike in interest rates.
The strategy is a form of financial insurance that typically pays off in the event of sudden selloffs, such as the pandemic-driven market chaos of last year. While McVey anticipates the current mix of economic trends and policy will drive a strong rebound in growth, he’s wary after the recent run-up in asset prices and the increase in Treasury yields.
“There are two or three things that could go wrong against a generally constructive backdrop,” KKR’s head of global macro and asset allocation said in an interview on Bloomberg Television.
Besides the potential loss of confidence in the dollar and a disorderly increase in rates, McVey also highlighted the “black swan” risk of a major disappointment in corporate earnings that could make investors re-evaluate equities. However, he thinks the probabilities remain low.
Tail-risk hedging is a small industry that includes LongTail Alpha in Newport Beach, California, and Universa Investments, a Miami-based firm advised by Nassim Taleb, the former options trader who wrote the 2007 bestseller “The Black Swan.” The LongTail Alpha hedge fund gained 10-fold in March, rewarding investors who bought protection against a market collapse.
KKR envisions a very different kind of recovery than the one that followed the 2008 financial crisis. Underpinning McVey’s outlook for accelerating growth are a healthy Chinese economy and proposals for fiscal stimulus from President-Elect Joe Biden. Plus, he expects U.S. consumer spending to pick up faster than most analysts expect.
“Our view at KKR is that rates will go up and the market has probably been too benign on inflation expectations, but we don’t see a rout,” he said.
McVey says the Federal Reserve ultimately may have to taper its bond-buying sooner than planned. He favors allocations to infrastructure, real estate and some credit. He also predicted a shift in capital flows from high-flying growth stocks to small-cap equities and emerging markets.
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