Nassim Nicholas Taleb is a legendary trader and essayist. He is famous for writing popular books "Fooled by Randomness" and "Black Swan," which discusses how one of “tail risk” event can have major consequences. During his time at Emirpirica Capital, Taleb racked up an astonishing 60% return forecasting the dot-com bubble of the year 2000. Today, he is an advisor at Universa Investments, an investment fund which specializes in portfolio insurance.
In general, the goal of this fund is to not lose money during the good times, but to make huge payoffs during a major crisis. For example, the fund has averaged close to a 10% annualized return, but in single month during a crisis, the fund racked up a substantial 3,700% return, according to Bloomberg.
In this discussion, I will summarize a 2023 Bloomberg Invest interview with Taleb and expand on some of his main points. Let's dive in.
Portfolio theory doesn’t work
Taleb is known for being controversial with his statements and investing strategies. In this case, he said, “Portfolio theory doesn’t work.” This is referring to the traditional 60% stocks, 40% bonds portfolio. Taleb believes this strategy does not work “mathematically and empirically.” However, it is still adopted by many pension funds due to simple replication.
Options strategy
The former trader said he “buys options” no matter what the external event, which is a contrarian strategy when compared to trying to forecast "nuclear war" or another major event. However, Taleb does not use the traditional Black Scholes model of option valuation. Rather, he has developed specific mathematical techniques which have made his firm successful as a type of portfolio insurance provider.
The world is more connected than ever
According to Taleb, the world is more connected than ever. A positive of this is people can communicate more easily and quickly transfer goods and funds across borders. However, there are also negatives to the rapid speed at which information travels and globalization. He pointed out that the great plague took 300 years to move from Israel to England. However, this same distance was covered by Covid-19 in just a weekend.
The result of this realization is increased volatility in the markets. In addition, many assets are also highly correlated, which means when one is trading low, it is likely the other will be also. Taleb’s whole strategy is focused on discovering uncorrelated investment strategies.
Antifragile systems
Taleb referenced his book “Antifragile,” which discusses systems which get stronger “when shocked” or go through volatility. As investors, it helps to identify these systems and assets during certain types of shocks. A simple example could be an e-commerce company such as Amazon.com Inc. (AMZN, Financial), which had its system shocked by the macroeconomic volatility of 2020, but ultimately ended up growing by around 50% in a short amount of time.
At a macro level, Taleb pointed out that, as a society, we are now stronger than when we were before the pandemic. This is because we are now used to wearing masks, implementing lockdowns, creating vaccines, etc. Therefore, should we have a worse virus in the future with a higher death count, we will be more prepared. This could be compared to having a fire drill to prepare for the event of an actual fire.
Interest rates and Ponzi schemes
Taleb believes the financial crisis of 2008 created a whole generation of traders who did not know what normal interest rates looked like. This was because the Federal Reserve set interest rates to below 1% for over a decade, which created a free money environment. In his mind, this created certain company strategies. Many companies were "selling” a negative free cash flow business with the hope of generating positive free cash flow in the future.
On a more extreme level, companies were just selling an idea for funding, which is in reference to the venture capital and special purpose acquisition company market. Taleb said the central bank “messed up” because they “don’t understand” how connected the world is. During the next crisis, he said the Fed should “moderate rates” more slowly. Taleb expects us to live in a world that does not have our zero percent interest rates, similar to the environment our “grandparents lived in.” To give historical context, interest rates of 5% are not high.
Housing market overvaluation
In regard to the housing market, Taleb said over “$130 trillion has been created in valuation.” He goes on to say if that does not go down by “half or three-quarters, something is wrong." He believes individuals will struggle to own a house worth $1 million, especially if just on $30,000 per year.
Invest or save
The danger of higher interest rates is the market must adjust to that new discount by adjusting prices downward. Higher interest rates also mean higher savings account rates, which makes savings accounts quite lucrative. Taleb believes the best financial advice in this current environment is for people to focus on “preservation” of capital earned from your job, as opposed to “speculation.”
Swiss bank failures
Taleb gave a humorous history lesson on Swiss banks after the failure of Credit Suisse (CS, Financial). In the “old days,” the Swiss banks “never took any risk.” They took your money and gave you “nothing in return.” According to him, it was the “most boring business model,” but it worked. However, then Taleb noted that the bankers from Zurich visited the U.S and started “dabbling with derivatives.”
As such, he believes this led to the downfall of the Swiss bankers as they “changed their business model.”
Switzerland was known as a great place for “bank secrecy” and for individuals to “hide their money.” But Taleb believes they lost this due to pressure from the U.S. and thus had to get into derivatives.
Is bitcoin a good investment?
Taleb has been a bear on bitcoin for a long time. He said, “Bitcoin isn’t even good for money laundering” as “it is too traceable.” He believes anyone with “basic knowledge of statistics” can triangulate it to find the senders and receivers, etc.
Another danger of bitcoin was it turned into a “cult,” which is always a risk when it comes to investing and valuation. A great example is the tulip bubble of the 1800s, where the flowers sold for the price of a house at one point. Finance has “gravity rules,” which means gravity can make it fall back down to earth.
He believes the claims that bitcoin is “good for transactions” is also false.
Final thoughts
Taleb is an iconic investor and trader. His insight on the markets is a breath of fresh air, as it often provides a unique or contrarian outlook. I believe the main takeaway from Taleb’s style is to think of your investment returns as a probability distribution and be aware of the “fat tail” or black swan events.
