Are financial advisors hedging against the wrong risk and paying a lot to do so?

Investors may be hedging the wrong risks - and are paying a boatload to do so.

According to Dhruv Maniktala, CIO of Western Alternative Strategies, most portfolios today are built to dampen routine volatility, generally 10% to 15% drawdowns that are normal and historically not harmful to long-term wealth. But he says those same portfolios are often left exposed to the rare, destructive events that actually break compounding and impair long term-wealth creation. 

In other words, Wall Street has created an expanding array of products and asset allocation models to promote protection against typical market corrections, often at a meaningful cost to upside market participation. Nevertheless, many of these same strategies and approaches offer little protection against a true “fat-tail” event.

InvestmentNews caught up with Maniktala to find out if clients are truly overpaying to hedge what doesn’t matter, leaving them woefully underprepared for what does. 

InvestmentNews: Why does traditional “risk management” often reduce returns without providing real protection?

Dhruv Maniktala: Traditional risk management suffers from the dual curse of reducing long-term returns while still incurring deep losses in a crisis environment. Approaches such as diversification, volatility targeting, and risk-parity work during normal markets but tend to fail in crises when correlations rise and liquidity disappears. Worse, the dilution of higher-returning risk assets with inherently lower returning diversification strategies also reduces long-term returns. Ultimately, traditional risk management optimizes for comfort, not survival. The cure is worse than the disease.

InvestmentNews: What is the difference between volatility control and true tail risk mitigation?

Maniktala: Volatility control seeks to reduce short‑term fluctuations, while true tail risk mitigation is designed to protect against extreme market dislocations that happen with more regularity than the average investor thinks. Volatility‑focused approaches assume markets behave within historical ranges, yet the most damaging losses come from sudden regime shifts outside those assumptions.

Tail risk mitigation uses convex structures that deliver asymmetric payoffs during crashes, when diversification breaks and losses accelerate. These strategies are expected to lose small amounts in calm markets but deliver outsized gains when systemic stress emerges. The difference is not cosmetic, it is structural.

Investmentnews: Why do so many portfolios remain structurally exposed to extreme market events?

Maniktala: Most portfolios are built around average outcomes, not catastrophic ones, because extreme risk is uncomfortable, difficult to model, and often dismissed as unlikely. Standard risk metrics underestimate the frequency and severity of tail events, reinforcing a false sense of security. Investors also face short‑term performance pressure, making the ongoing cost of protection appear unattractive. As a result, portfolios rely heavily on diversification that breaks down precisely when it is needed most.

InvestmentNews: How do institutional investors approach this differently and what’s changing for RIAs and individuals?

Maniktala: Large institutions have long treated tail risk like insurance, accepting small, persistent costs to reduce the probability of catastrophic loss. Pensions, endowments, and sovereign wealth funds focus on protecting long‑term compounding rather than minimizing annual tracking error. Historically, these approaches required specialized expertise and scale, limiting access for smaller investors.

That is beginning to change as awareness grows around systemic fragility, leverage, and geopolitical risk. RIAs and individuals are increasingly questioning whether traditional portfolio construction alone is sufficient for extreme environments. Unfortunately, in response to this reality many private wealth advisors and investors appear to be gravitating to downside protection products such as structured products and buffer ETFs which will not protect against extreme market events.