No risk, no reward.
While Mark Spitznagel wouldn’t disagree, a letter from the star hedge-fund manager seen by The Wall Street Journal has some striking insights on both fronts. A protégé of “Black Swan” author Nassim Nicholas Taleb noted on the occasion of his fund’s 15-year anniversary that using it to hedge a standard stock portfolio would have enhanced long-run returns through its bets on extremely bearish events.
That isn’t remarkable, but the enormous impact of his technique is. Just a 2% allocation to Universa Investments, with the remaining 98% in an S&P 500 index fund, would have produced an 11.8% annualized return over the fund’s life compared with 9.6% for an index fund alone, according to Mr. Spitznagel. As he states in the letter, this means one dollar invested at the outset in the combination would be $5.20 now, with the 2 cents invested in his fund alone rising to an eye-watering $1.30. But that assumes rebalancing. The letter claims the fund alone had a mind-boggling annualized return of 114%.
Universa, which bets on extreme market fluctuations, inherently has its gains come in big chunks interspersed with long periods of small, steady losses. For example, when Covid sent global markets into a tailspin, returns were an estimated 4,000% in the first quarter of 2020. The fund also made $1 billion in a single day in 2015 during the “Flash Crash.”
Universa’s returns are “convex” rather than linear, meaning that increasingly extreme moves will produce outsize gains: The fund’s anniversary letter calculates that a month with a 20% market drop could produce a return for the fund as high as 7,835%. While not giving away Universa’s secret sauce, the letter notes that any other common risk mitigation strategy, such as owning gold or Treasury bonds, would have lost money over the past 15 years—even a classic “tail risk” strategy that uses derivatives, as Universa does.
With far less-successful money managers being sought out for their every utterance about the market, someone who has made investors 60 times their money might be solidly booked as a talking head. But Mr. Spitznagel neither makes short-term calls nor keeps his cards close to his vest—he lays them on the table for everyone to see. By rolling over bets on extreme events, he loses nearly every hand while wagering small sums and occasionally rakes in a huge pile of chips.
The only prediction he makes is one that investors who follow him have heard many times over more than a decade—that the financial system is due for a serious reckoning. In this latest letter, he calls it “objectively the greatest tinderbox-timebomb in financial history—greater than in the late 1920s, and likely with similar market consequences.”
A Great Depression style wipeout is quite the call, yet Mr. Spitznagel offers no timeline and suggests that the conscious postponement of a crash has contributed to its eventual severity. The analogy—one he has employed in the past—is that monetary and fiscal firefighters have been overzealous at stamping out financial conflagrations, setting the stage for an uncontrollable blaze.
These apocalyptic predictions are where one suspects the consistent, coldly mathematical hedge-fund manager might be allowing his political views to color his commentary. He is closely associated with former presidential candidate
who has sought to abolish the Federal Reserve and restore the gold standard and who has been making similar calls for decades. “The savings of millions could be wiped out. You can’t rely on Washington to help you,” he said in a 2015 ad. By explaining away the role of monetary and fiscal policy in averting crises as merely bottling up problems for an even bigger wipeout, the many years of failed predictions not only stay alive but gain heft.
The upshot for ordinary investors is faintly reassuring, though, according to Mr. Spitznagel. Rather than trying to replicate a Universa-style safe haven strategy or moving into some “safe” asset class like gold bars, the least-bad alternative might be to just to buy and hold stocks passively through the cycle, as
and others have advised. He has suggested that, absent the opportunities he has as a mathematically-sophisticated hedge-fund manager, that is probably the least bad course of action to preserve wealth in the conflagration that he foresees.
Write to Spencer Jakab at [email protected]
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