Sunday, June 17, 2012

Is Spitznagel an Apostate?

Mark Spitznagel, former employee of Nassim Taleb, has run the Universa Hedge fund for a while and seems to be doing quite well for himself (he bought Jennifer Lopez and Marc Anthony's old home in Bel Air). What his returns have been I don't know, but they are always reported second-hand when vol spikes (as usual regulation is the opposite of helpful here, discouraging hedge fund reporting that would allow investors to more accurately estimate returns for various strategies).

Anyway, Taleb's Black Swan investment advice seemed to be a barbell strategy with a lot of something really safe balanced by radical risky investments. Because people don't appreciate the magnitude or frequency of infrequent events, these low-probability but large impact events offer good returns. In this white paper, Austrians of a Feather, Spitznagel seems to be saying that doesn't work. He seems enamored by Austrian business cycle theory, and an unfortunate side effect of which is to abjure clarity and concision. Thus I'm not sure what he's trying to say, but it seems he is saying that tail risk, out-of-the-money options and their ilk, are fairly priced if not overpriced. The real market opportunity is in predicting specific Black Swans. In other words, speculating on rare events, as opposed to presuming rare events are under appreciated in general.

 Taleb is listed rather prominently on the Universa Website and Spitznagel graciously credits Taleb in the paper, but Taleb and/or Spitznagel have put a fork in the archetypal Black Swan theory (and yet, Taleb has never been really consistent, so one can say he meant this all along at some level). I have no doubt some people can predict infrequent events, and perhaps Spitznagel is one of them. Yet it's pretty hard to validate objectively, and in my experienced is best done via observing all the little good investments someone has made for 10 years, something that is impossible to do in scale. The idea that if you can predict infrequent events you can do very well for yourself is true enough, but that's a lot less useful to know than if rare events are unappreciated in general, which turns out not be be true.


Anonymous said...

Nice observations Eric. I would say Spitznagel has indeed put a fork in Taleb's Black Swan. His Austrian paper seems pretty clear and compelling to me, basically stock market crashes haven't been black swans, and long dated options are expensive. (Spitznagel acually says "If there is a blatant trade idea in this paper, it might just be to sell five year variance." Ha!) And seems to me Spitznagel's returns (still up over 100% since inception, making him certainly a top performing investor out there, based on Bloomberg reporting..and I get your skepticism Eric) seems to validate, at least thus far, his ability to predict crashes, infrequent or not. Though, as Eric has pointed out, Taleb wasn't much of an investor when he ran money at Empirica. Perhaps Spitznagel's best trade yet was ditching Taleb and his ideas?

Mercury said...

I don’t think Spitznagel is poking holes in Taleb’s Black Swan theory so much as he’s illustrating how the Austrian school’s model for how economies work is much more accurate than the dominant, quasi-religion of Keynesian central planning. One man’s black swan is another man’s white swan if the second guy has a better grip on what is actually happening.

What’s confusing is this:
“To the relentless willingness by most investors (as witnessed through my career, and indeed for at least the past century) to repeatedly price in the almost certain success of inflationary credit expansion, I owe my past and future success in betting against them; that is, betting on their assumptions about what are rare events.”

If this is the case, tail risk should be underpriced by a market of believers, not fair-overpriced. But perhaps various flavors of equity index insurance are the wrong tools to hedge with at this stage in the game. Who thinks that the Fed wouldn’t do everything in it’s power to prevent an equity market crash including printing money and buying the market directly (which they have already done to some extent)? If something like this came to pass, it would cause other problems obviously but the stock market would stay above a certain nominal level and your long dated, out of the money puts might not pay off as you hoped (as other parts of your economic life go to hell) – which is maybe why they’re ~cheaply priced now.

Between the US and the EU alone there is more debt outstanding than can ever be paid off. So, via default, inflation, coercion or capital controls, someone is going to take it in the neck and the government(s) is going to do their best to make sure it won’t be them. Gold, hard assets, commodities and international diversification may or may not be the best way to hedge against this but I like them all better than S&P 500 insurance. In fact, the more a trade overlaps with “short central planning” the more I like it in this context.

I understand one of Taleb’s major themes to be that black swan event risk increases as complexity increases. Banks (for instance) should be much smaller, more utilitarian and have less ability to create money via repo, rehypothecation and the securitization of everything. Still makes sense to me and I think it meshes with what Spitznagel is saying about the “economic illusion created by monetary policy“ which is fostered by the mechanics of modern finance (can anyone really explain, at this late date, where MF Global client’s money went?)
and mega-banks who are joined at the hip to the Fed.

Max said...

The thing you wonder when you read something like this is, is this guy high on weed, or is it just a calculated appeal to the prejudices of his clients?

Anonymous said...

Funny comment, Max. But Spitznagel's empirical analysis is solid. I'm sure you are protesting his rather right-Ron Paul-leaning Austrian devotion. But if most didn't scoff at this type of analysis then there wouldn't be such valuations in the first place. I for one wouldn't want to fade one of the few investors who got it right, and I appreciate his honesty that cheap markets don't need tail hedging.

Max said...

Like most people Spitzenagel equates low interest rates with an inflationary Fed posture, which is totally false. Interest rates were low in the 1930s, high in the 1970s. This is what tight money looks like.

Anonymous said...

My comment is: why the heck did you use the word "abjure"? I know what it means and don't understand what you've written or mean.

His being enamored of the Austrian business cycle (an Austrian "model" I've heard of, but an Austrian "cycle"? Maybe I'm ignorant here) repudiates, foreswears or denies clarity or things being concise? Please be clear and concise yourself.

Anonymous said...

Max you might want to review a subject before criticizing. Spitz is specifically tracking implied profit spreads, certainly not market rates. (Did you even read the piece?) Austrians are famously known for saying cannot understand what's going on from rates (or inflation), they give many other such examples.  And I'm sure Spitz and his Austrians would not argue that we aren't currently in a big deleveraging, part of his whole bearish case I'm sure.

compare electricity prices sydney said...

Spitznagel is notable as perhaps the most prominent Austrian (School of economics)-focused investor, particularly among large active investment managers, as well as one of the school's most vocal proponents.