Many advisors also look to alternative asset classes to reduce risk. "There are still no magic bullets, but some new investing strategies are emerging that can help protect a portfolio from major losses and still offer plenty of upside," says Jerry Miccolis, the chief investment officer at Brinton Eaton in Madison, N.J.

Miccolis invests up to 35% of his client's assets in alternative investments, including managed futures, market neutral strategies and absolute return strategies, in addition to real estate and commodities.

He also has a position in a custom structured note created by Deutsche Bank called EMERALD. This promissory note works by exploiting the equity market's quirky behavior. The S&P 500 index moves a great deal from day to day, but rarely moves in the same direction for many days in a row, and its movement from week to week is typically less than daily movements would imply. There are usually intraweek reversions-even during market collapses.

EMERALD exploits this behavior by placing daily bets. "The hedge is one that kicks in when you most need it, but doesn't represent a drain on your portfolio in normal times," Miccolis says.

Some advisors conduct stochastic simulations to find the middle-the best combination of assets that hold up well during periods of low volatility and stable correlations and also during periods of high volatility and rising correlations.

Richard Michaud, president of Frontier Advisors, Boston, uses an optimization model called "Resampled Efficiency" to reduce tail risk. "Even small changes in optimization inputs often lead to large changes in [traditional] optimized portfolios," he reports in a research study posted on his Web site (www.newfrontieradvisors.com).

He uses "resample efficiency" to optimize and rebalance portfolios. The methodology uses Monte Carlo simulations to resample optimization inputs. The rule computes a "need to trade" probability. An optimized portfolio can be rebalanced when another asset mix shows a greater probability of success.
"Resampling creates additional returns and new optimization inputs that are statistically equivalent to the original set," he says. "The efficient frontier portfolios based on these new inputs are likely to look very different."

Other financial advisors include tail risk hedging in portfolio management strategies. Dynamic hedging is one type of program that incorporates the use of put options to limit the downside. This type of program considers a hedge ratio-the amount of put options needed to hedge against the risk of losses. Put option hedge positions are rebalanced as market conditions change.

The dynamic hedge takes into account the amount by which an option's price will change for a corresponding change in the price of the underlying security. This is adjusted as the price of the portfolio it hedges changes. Meanwhile, the change in the price of the option also is hedged.
Rick Lager, president of Lager & Co., Minneapolis, says his portfolio program helped him almost entirely avoid the 2008 financial meltdown. Lager typically manages 401(k) plan assets of $500,000 to $1 million for clients in their fifties. He hedges client retirement savings with put options in their taxable accounts.

Lager makes hedging decisions based on a program designed by Dorsey Wright & Associates, Richmond, Va. He hedges his portfolio, based on long-term, medium-term and short-term price trends and bullish percentage measures. Then he sells stocks and moves some money to cash and/or hedges some positions with puts.