Many financial advisors may be paying a steep price to hedge against the wrong risks, according to Dhruv Maniktala, chief investment officer of Western Alternative Strategies. In a recent interview, Maniktala argued that conventional portfolio construction focuses on dampening routine volatility—typically 10% to 15% drawdowns that are historically benign—while leaving clients exposed to the rare, catastrophic events that actually break compounding and erode long-term wealth.
Maniktala pointed to a proliferation of products and asset allocation models designed to protect against typical market corrections, often at a meaningful cost to upside participation. Yet these same strategies, he said, offer little defense against a true “fat-tail” event—a sudden, extreme market dislocation that occurs more frequently than many investors assume. The result, he warned, is that clients are overpaying for comfort rather than survival.
The Dual Curse of Traditional Risk Management
Traditional risk management, Maniktala explained, suffers from a “dual curse”: it reduces long-term returns while still incurring deep losses during crises. Approaches such as diversification, volatility targeting, and risk-parity tend to work in normal markets but fail when correlations rise and liquidity evaporates. “The cure is worse than the disease,” he said, noting that diluting higher-returning risk assets with lower-returning diversifiers also drags down compounding over time.
Maniktala distinguished between volatility control and true tail risk mitigation. Volatility control seeks to reduce short-term fluctuations, assuming markets behave within historical ranges. Tail risk mitigation, by contrast, uses convex structures that deliver asymmetric payoffs during crashes—strategies expected to lose small amounts in calm markets but generate outsized gains when systemic stress emerges. “The difference is not cosmetic, it is structural,” he said.
Structural Exposure to Extreme Events
Why do so many portfolios remain vulnerable to extreme market events? Maniktala attributed this to a reliance on average outcomes rather than catastrophic ones. Standard risk metrics, he argued, underestimate the frequency and severity of tail events, reinforcing a false sense of security. Short-term performance pressure also makes the ongoing cost of protection appear unattractive, leading advisors to favor diversification that breaks down precisely when it is needed most.
Large institutions—pensions, endowments, and sovereign wealth funds—have long treated tail risk like insurance, accepting small, persistent costs to reduce the probability of catastrophic loss. Their focus is on protecting long-term compounding rather than minimizing annual tracking error. Historically, these approaches required specialized expertise and scale, limiting access for smaller investors. However, Maniktala noted that awareness is growing among RIAs and individuals around systemic fragility, leverage, and geopolitical risk.
Unfortunately, many private wealth advisors and investors are gravitating toward downside protection products such as structured products and buffer ETFs, which Maniktala said will not protect against extreme market events. This trend, he suggested, may leave portfolios underprepared for the very scenarios that matter most. For advisors seeking to build more resilient portfolios, the lesson is clear: hedging against routine volatility is not the same as preparing for the rare, destructive events that can derail a client’s financial plan.
As the industry grapples with these challenges, some advisors are exploring alternative approaches. For instance, a recent Northwestern Mutual Index found that Americans' personal prosperity score hit 68, with advisors boosting sentiment—a reminder that client confidence can be fragile. Meanwhile, the global UHNW population is projected to reach 734,100 by 2030, underscoring the growing need for sophisticated risk management among high-net-worth clients.
