As practitioners providing tail risk hedging solutions to investors, we are often asked to supply return time series and compounded returns for tail risk hedging strategies. The purpose of this paper is to illustrate with simple, hypothetical examples why cash flow based analysis is central to evaluating strategies with high volatility payoffs. While the traditional NAV based fund accounting is not incorrect, we often have to explain to investors that the meaning of such data has to be thoroughly understood before it is used in making portfolio decisions. The need is even more critical today, since current portfolio optimization approaches and software, such as single period optimization using a mean-variance type of approach, can give precisely the wrong answer if the correct inputs are not used.
The full note on this important topic can be downloaded at this link: LTA Thinking – Cash Flows Matter for Tail Hedging Strategies