To make a portfolio antifragile, we need to create a system that favors:. Thus, a lower risk can be achieved by lowering the size of the individual investment. This is achieved via diversification. The riskier the individual bet is, the smaller the investment should be. And the many investments in a portfolio should be uncorrelated.
High upside : We want the potential gains to outweigh the losses greatly. In this context, we are looking for long-shots where the payoff is significant. The ideal investment profile will be a company that is still young, growing fast, with a long runway ahead that could lead to tremendous value creation over time.
If significant risk exists in a single transaction, overall risk should be reduced by making that purchase one of many mutually- independent commitments. Thus, you may consciously purchase a risky investment — one that indeed has a significant possibility of causing loss or injury — if you believe that your gain, weighted for probabilities, considerably exceeds your loss, comparably weighted, and if you can commit to a number of similar, but unrelated opportunities.
Most venture capitalists employ this strategy. In his book Zero to One , Peter Thiel explains that a rule for VCs is to " only invest in companies that have the potential to return the value of the entire fund " more on that later. It might sound romantic and unrealistic at first. How can we apply this reasoning to a portfolio strategy?
By setting the expectation that your next pick needs to have the potential to beat the performance of all your other investments combined, you are setting the bar extremely high. If you are trying to achieve a small gain due to a temporary inefficiency in the valuation of a business, you are likely breaking the rule suggested by Thiel. The mindset required to set the bar very high for all of your investments will likely help you avoid value traps and only seek excellence.
The reason why the growth stocks do so much better is that they seem to show gains in value in the hundreds of per cent each decade. In contrast, it is an unusual bargain that is as much as 50 per cent undervalued.
The cumulative effect of this simple arithmetic should be obvious. This implies a strategy that tilts heavily toward a growth factor companies with unlimited potential. One of the flaws of an investment strategy tilting toward value is that investors can be really intrigued by companies simply because they appear "cheap," which would fail Taleb's requirement.
VC funds don't invest in companies just because they look undervalued. Instead, they invest in companies because they have tremendous potential, surf a secular trend, and have the capacity to disrupt an industry, with years of growth and compounding ahead. Finally, your time horizon is the last ingredient to allow for a high upside. VC funds benefit from a significant counter-intuitive advantage. Their investments are usually illiquid and remain so for years.
While it may sound like a constraint at first glance, it's actually a huge advantage to avoid common mistakes such as pulling the money out too soon or trading too much in and out of a position, creating unnecessary tax inefficiencies. In his book Zero to One , Peter Thiel explains:. The biggest secret in venture capital is that the best investment in a successful fund equals or outperforms the entire rest of the fund combined.
You are probably familiar with the bell curve, also known as the normal distribution. In a bell curve, data has less of a tendency to produce unusually extreme values outliers. A good example of a bell curve is the roll of two dice. The distribution is centered around the number seven, and the probability decreases fast as you move away from the center standard deviation.
However, Thiel argues that the world is governed by another distribution called the power law. And it should set your expectations for your own portfolio performance. Such a distribution involves "fat tails" compared to a normal distribution. An option allows its user to get more upside than downside as he can select among the results what fits him and forget about the rest he has the option, not the obligation …. Payoffs from research are from Extremistan; they follow a power-law type of statistical distribution, with big, near-unlimited upside but, because of optionality, limited downside.
I reviewed my own stock portfolio to observe the same results. Taleb argues that in an antifragile strategy, the more bets you make, the better. The greater the number of investments in the portfolio, the lower the cost of failure the permanent loss of capital on an individual investment. A portfolio with dozens of small investments has a lower chance of failure than one with a single large investment.
It's just math. A large number of stocks is often mistakenly perceived as a recipe for average performance. However, during his tenure as manager of the Magellan Fund, Peter Lynch held as many as 1, stocks at some point. Such a large number didn't prevent him from creating outstanding alpha. A small cost of failure is guaranteed by defining a maximum amount allocated to an individual position.
Following the power law, the majority of the gains of the portfolio should come from a rare event called a "Black Swan" by Taleb. Of course, we don't know the winners ahead of time, but by increasing the number of positions, we increase the odds of a major winner being present in the portfolio. Thus, investing in only a handful of stocks would require the belief that you can accurately pick among the very few stocks that will deliver outstanding performance.
Accepting this reasoning requires some form of humility. If you embrace the premise that the world is uncertain, there is no place for a portfolio with only a handful of initial investments. No matter how high your conviction and how deep your knowledge is, it would only take a few wrinkles for a well-thought-out plan to be doomed. An antifragile portfolio involves more swings because it statistically leads to the potential for more home runs.
Portfolios starting with only a few positions are fragile by nature which doesn't mean they can't succeed. Warren Buffett is known for making concentrated bets. However, his initial positions remain reasonable. Many investors would argue that they would rather own a few positions that they study and know perfectly. They like to "do their homework. It doesn't matter how well you know your investment if it turns out to be a loser.
More swings statistically lead to more home runs, and you don't need that many home runs in your life to achieve your financial goals. You do so by starting with a small position and accepting that it won't always work. To maintain the optionality of a portfolio, the investor needs the ability to change her mind and stay flexible. Mathematically, five sequential one-year options are vastly more valuable than a single five-year option.
In practical terms, an investor should always be ready to sell if an investment thesis is broken. The way a bull case fails to deliver can take many forms and should be based on the original thesis. A disappointing guidance or insider selling should rarely be of relevance in a sell decision.
But if an investment thesis was based on key personnel ultimately leaving the company or a product development that turns out to be abandoned, there should be room to re-assess and part ways with shares early. I personally struggle with this idea because I rarely ever sell. I do so to let my winners run. The drawback is that I tend to hold my losers for tax-loss harvesting purposes for a long time since I have no capital gains to offset that specific year.
I apply 4 Simple Rules to protect my portfolio. One of them is "Don't add to your losers. Thus, holding or selling them would have little impact on my overall returns. Nevertheless, I should be keener on letting go of a past loser and have more flexibility in my approach if I want to benefit from the serial optionality described by Taleb fully. After all, every new investment resets the clock and offers the potential for high upside and low downside once more. I discussed previously the Narrative Fallacy and how stories can distract us from facts.
We are all drawn toward investments that have a great story to tell. Stories are inspiring and easy to remember. But, unfortunately, they can take over our rational minds, and we abandon all evidence-based research in their favor. Non-narrative action: Does not depend on a narrative for the action to be right—the narrative is just there to motivate, entertain, or prompt action.
The remedy here is to focus on the facts and the knowable. Do you see a trend or a pattern that confirms the story? Or is it simply window dressing? What do we learn from the quarterly Q or annual reports K? What does management have to say in the earnings calls? You want to judge things as they are statistically or logically, rather than as they merely appear. Ultimately, it should be evident based on the fact when an investment is demonstrating optionality.
Meanwhile, businesses presenting the opposite traits have negative optionality and should be avoided highly leveraged companies, losing talent and market share to competitors, focused on a niche, in a secular downtrend, and so on. Rather than investing in a good story, Taleb would rather prioritize strong facts.
A story could take many turns and will likely look very different than anticipated, no matter what. Thus, we merely want to look for the right ingredients. It's essential to recognize that our best-performing investments will often do so for unforeseen reasons. The FANG stocks have been huge winners for reasons that could not have been anticipated at their inception:.
It's important not to cling to a narrative. Facts change constantly. To maintain an antifragile portfolio, it's essential to iterate and be willing to review the facts and make new decisions. This applies to a bull case gone awry or a previously discarded opportunity that's become relevant.
Lefty Gomez, an all-star pitcher for the New York Yankees in the 's, is famously credited with saying, "I'd rather be lucky than good. It's a simple adage. I would rather win the game than lose with talent. There are no brownie points for being talented in investing. Ultimately, luck plays an essential role in an investor's journey. As investors, we all tend to attribute good outcomes to our skills and bad outcomes to sheer luck or lack thereof.
We choose how to explain the cause of an outcome based on what makes us look best. Unfortunately, this type of bias limits our ability to learn from our mistakes. Hindsight bias can be very damaging over time since it can:. It's critical to appreciate the role of luck in our investing journey.
Because once you do so, you are empowered to maximize the odds in your favor. Ultimately, putting the odds in your favor matters immensely more than any edge you may have. The graph below is a random simulation from Taleb, showing the performance impact of:. For Taleb, it's more important to define a system that maximizes the odds of success rather than letting the illusion of skills take over the decision process.
It is far easier to figure out if something is fragile than to predict the occurrence of an event that may harm it. Fragility can be measured; risk is not measurable. When making an individual investment decision, the process matters immensely more than the outcome. Annie Duke perfectly sums it up in her book Thinking in Bets :.
What makes a decision great is not that it has a great outcome. A great decision is the result of a good process, and that process must include an attempt to accurately represent our own state of knowledge. Create systems to recognize your odds rather than relying on individual excellence. In some of our most successful investments, the amount of work that was done was in the hours as opposed to even in the days or weeks or months.
In investing, there is no bonus point for complexification. David Perell recently touched on this with his short essay The Stupid Test. Many investors avoid ideas that seem too mainstream or too stupid. There is a tendency for smart people to overcomplicate things. He explains:. When you insist on working hard, even when it's not the most effective strategy, you miss obvious solutions that are right in front of your eyes. I've also found that my simplest ideas have also been some of my best-performing investments over the years.
To illustrate, you can find my past bull cases shared on Seeking Alpha for companies like:. These articles were a few thousand words long and didn't come with complex mathematics or an elaborate financial model. These companies demonstrated optionality by displaying the non-narrative attractive traits I previously touched on. If your investment decision requires a complex DCF model, you are probably doing it wrong. That's even more true if you accept Taleb's premise that we live in an uncertain world.
For example, predicting the next 10 years of cash flow of a fast-growing, innovating company is pointless. Instead, focusing on clearly defined qualitative factors and trends can lead to better payoffs. If you have applied the rules discussed above, your portfolio is already in great shape. The last step is to document what goes right and what goes wrong and adjust accordingly. There is no guessing. It simply requires looking at the performance of your investments and making sure to gain insights from them.
Taleb emphasizes an outcome-based model, where you reach your conclusion after the fact:. All you need is the wisdom to not do unintelligent things to hurt yourself some acts of omission and recognize favorable outcomes when they occur. It might sound like a simple premise, but we were just discussing that simple is beautiful, weren't we? Most of Berkshire's success grew from stupidity and failure that we learned from. I hope that makes you feel better about your own life.
I apply this by ensuring I don't get in the way of my portfolio's success. I let my losers become a small part of my portfolio by not adding to them doing less of what doesn't work. For example, I would label tobacco, alcohol, and the brothel industries as robust and resilient.
Despite recessions, shocks, and changes in consumer preferences they have managed to withstand the test of time — like rocks. Highly likely there will always be a market for these products, either because they are addictive or serve a need for human nature brothels. They are little exposed to disruption. However, being antifragile can make a business evolve into something much stronger and better than simply being robust.
Most likely such a company derives its antifragility from its culture, not products or services. Amazon is partly an antifragile company. As of writing the coronavirus is spreading from country to country, but I believe Amazon can benefit from the virus.
Being antifragile is about having an organization that is receptive to change and can benefit from change and shocks. Google provides a cultural environment that stimulates small-scale experiments which occasionally result in a big payday.
This means Google can gain on randomness! Warren Buffett says he always keeps a solid buffer in cash for unknown and unpredictable events, making Berkshire Hathaway somewhat antifragile. He wrote the following in the shareholder letter of on page Over the years, a number of very smart people have learned the hard way that a long string of impressive numbers multiplied by a single zero always equals zero.
That is not an equation whose effects I would like to experience personally, and I would like even less to be responsible for imposing its penalties upon others. Why does Buffett want to have so much idle capital? One reason is that he is forced to as an insurer. However, there is another important element: he has skin in the game. Decision-making is decentralized — thus much more antifragile and receptive to change. Buffett simply does things without any grand strategic plan.
We can think of Berkshire as some kind of self-managed company where there is no top-down hierarchy. Empirical evidence suggests this is much more important than the size of the salary. Another example of a decentralized and antifragile business is Canadian Constellation Software. We believe the Berkshire model is the closest you can come to a business model that is antifragile. There is no guarantee they will perform well, but we suspect they might in the long run :.
Opposite, we have a business that needs to be handled with care, like for example a capital intensive, competitive, and cyclical business. Such a business is at the mercy of the economy, and additionally could potentially be bankrupted if it uses leverage to boost returns. Unfortunately, the vast majority of the public companies are within this category as explained by Hendrik Bessembinder in his study from Just a tiny number of stocks have turned out to be good long-term investments because the competitive marketplace forces most return downward.
A recession reveals those swimming naked. Currently, the coronavirus has halted tourism and transport, putting a lot of strain on airlines, a very fragile business. On the 5th of March , the International Air Transport Association IATA wrote a statement where they expect airlines to lose between 63 to billion in revenue in , depending on how the coronavirus spreads. The chart of Norwegian Air Shuttle an airline listed on Oslo Stock Exchange serves as a great reminder of the problems of investing in such an industry:.
For ten years the share price has gone nowhere. Despite this, as a consumer I have benefited handsomely by being able to travel cheaply back and forth between Norway and my home, usually at less than EUR for return tickets a 90 mins direct flight. Companies that depend primarily on physical assets like real estate, factories and machinery for their competitive advantage are unlikely to earn reliably superior returns on their invested capital over the long term.
Physical assets invite replication by competitors which often leads to excess capacity, price competition and erosion of returns on capital. In contrast, companies whose decisive assets are intangible, such as brands, patents, licenses, copyrights and distribution networks, can earn consistently superior returns on relatively smaller amounts of invested capital. Elmasry measured returns against capital intensity in 2 public companies from both the US and Europe from to His result found an inverse correlation between returns and capital intensity:.
The evidence confirmed our own anecdotal experience as professional investors. As previously discussed, we believe that this is because capital-intensive companies typically rely on tangible assets for their competitive advantage which can easily be replicated by competitors. This ease of replication encourages plentiful capacity, tough competition, weak pricing and lower returns on capital. In contrast, companies that are dominated by intangible assets can benefit from a more benign pricing environment, higher returns on capital and superior organic compounding of wealth.
Investors should benefit from an investment approach focused on low capital intensity companies driven by vibrant intangible assets. Credit Suisse looked at the returns for 10 stocks in 68 different industries by looking at returns on invested capital. The graph below shows the difference between CROIC cash return on invested capital and the cost of capital.
There are of course companies that make good returns in an industry that on average makes a loss, and there are companies that are losing money in an industry that on average is very profitable. However, unless a company is outstanding, there are industries that perhaps should be avoided:.
In the paper by Credit Suisse, they did a deep dive into the airline industry to investigate where the most profitable niches are. The figure below shows the profit pool for all these industries as a whole. Airlines and airports use the majority of the capital, but at the same time are the businesses with the lowest returns.
Just a few businesses make all the returns — those with the least capital requirements — but the profits are too small to offset the value destruction from the airlines and airports. In the edition the authors Dimson, Marsh, and Staunton, the three professors behind Triumph of the Optimists , contributed an article where they looked at the best industries in the US and UK between and The worst industry was shipping with only a 6. Shipping is a capital intensive business, while tobacco is the opposite.
The stock market is full of volatility and randomness. Companies come and go, and most companies simply vanish — they get merged, acquired, go into oblivion, or go bankrupt.
Or in other words, what types of businesses actually create value in tough environments? So as an investor, as long as you have the endurance to hold through whatever Mr. Market may have in store on the downside, you can actually come out on the other side in better position because of the work you did buying right beforehand. Examples from the time frame would be things like Berkshire Hathaway on the large cap side of things, and Cambria Automobiles on the micro cap side of things.
I'm thinking more about this lately because while markets have come down a bit, they are still at lofty valuations. But I'm seeing more interesting things to look at that seem like they could be very cheap than I have in a long time, which is a bit ironic given that I just exited from the investment business and am not currently managing outside capital. At any rate, while I was still at Boyles, we wrote the excerpt below in a investor letter after finishing Taleb's book, and I think it still reads fairly well, so I included it here for those that are interested.
The fragile is harmed by certain shocks, randomness, and stressors. The robust is neither harmed nor helped by them. And the antifragile grows and improves from them. And by trying to avoid fragile traits and invest in situations that are more robust or, preferably, antifragile, we decrease our chances of making mistakes due to estimation error.
Below are some examples of these traits among businesses and investments:. When the positive traits overwhelm the negative traits, we can be fairly confident that the odds are in our favor. But figuring out which traits are really present and which are illusory takes a lot of work; as does coming up with a proper and conservative estimate of intrinsic value and a worst-case scenario.
The math behind the Kelly Criterion gives a good framework for thinking about the questions: 1 Is my probability of winning greater than my probability of losing? Investing more than a small allocation in something as new and as-yet-unproven as Bitcoin is not a thoughtful asset allocation strategy. In , I began reaching out and talking with hedge fund managers specializing in high volatility and black swan scenarios.
I burrowed down the rabbit hole from there, reading a range of books and research papers. I started to dabble in trading options, a common tail risk strategy, to understand how they worked. Through that process I met Jason Buck, an investor with over 20 years of trading experience. He had spent the next decade working with family offices and high net worth individuals to build more antifragile portfolios. He had found some answers. There were some pretty good answers to the questions I had been asking.
There were people who had worked to figure out viable approaches to tail risk hedging against black swan events. They were attempting to find a way that investors could add an effective form of diversification to their portfolios. Diversification generates higher returns with fewer declines over the long run.
For one, this allows investors to achieve higher returns. For another, it leads to less stress for investors. A diversified portfolio means having some assets that go up while others go down and vice versa. The challenge is how to actually do that well. The year showed how interwoven the global economy is today.
A seemingly isolated risk like U. If Mr. To be truly diversified, investors need something that reacts positively to tail risk events like and actually benefits from volatility. True diversification requires some element of antifragility, something that benefits from volatility, in a portfolio. While many investors believe they have diversified portfolios, the reality for nearly all investors is that almost everything in their portfolio is fragile and harmed by volatility.
But, I also learned that there are some challenges with existing solutions. One common solution for adding a tail risk long volatility asset to a portfolio is using government bonds, particularly U. Treasury bonds. Over the last 30 years, when stocks have fallen, government bonds have increased, providing diversification. The inconvenient truth for many of these portfolios is that U. Treasury bonds have only very recently been an effective form of diversification and may not be in the future.
When the stock market has fallen over the last thirty years, the Federal Reserve has cut interest rates which increases bond prices as stocks are falling. According to interest rate historian Jim Grant , rates have never been lower in the 3, years of recorded interest rate history. So while no one knows what the correlation will be going forward, there is, at least, some reason to be skeptical that the recent historical anomaly will continue into the future.
The alternative that Jason has been researching and implementing was to try to hedge using products that are more directly negatively correlated to traditional markets. The challenge with similar option buying strategies is that they tend to lose money in good years. This is particularly true today.
If you started using most of these strategies in , you would have been losing your premium every year. What Jason realized is that investors needed to find products that benefit from tail risk events and market crises without paying so much insurance premium in good years that you miss out. Investors need a dynamic tail risk strategy that instead of buying insurance on the whole market all the time, buys insurance on the risky parts at the riskiest times.
It would be expensive to insure all the forests in the world, all the time, against all forest fires. But, if you insured just against certain areas, and just when they were dry and had high winds, you would get nearly all of the protection you needed, but at a small fraction of the cost. In January , Jason convinced me to go to Miami for an alternative investments hedge fund summit where we met with many of the hedge fund managers I had been researching.
We talked to existing managers who were employing the kinds of dynamic tail risk strategies that worked. However, there were some challenges. One was that minimum investments tended to be high, upwards of a million dollars. This made it difficult for most investors to get access to these types of strategies.
Some specialized in monitoring and insuring against areas with high winds. Others focused on insuring particularly dry areas. They each had scenarios where their particular tail risk strategies might not catch a down move in markets or might lose premiums at an unacceptibly high rate. They were all buying insurance on slightly different parts of the forest at slightly different times.
By combining a handful dynamic tail risk strategies, we came to believe that you could get something like better coverage for a lower premium. The same appeared to be true of options and volatility strategies, so it became clear to me that it made sense to use professionals. And so we set out to see if we could actually build such an investment strategy. We spent a year doing due diligence on dozens of potential strategies, building upon the thousands of hours Jason had spent in the preceding decade as well.
We partnered with RCM Alternatives , an award-winning year-old firm managing billions of dollars, piggybacking on their ongoing due diligence of these managers, extensive database of hedge funds, and expertise in analytics and measuring risk and reward profiles. Why did we call it Mutiny? Market is the captain of our financial lives. And while he may be right much of the time, he must be held in check.
His role is to take control of the ship, ensuring the safety of all aboard and sailing onwards into calm waters. To help achieve this, the Mutiny Investment Strategy aims to limit the cost of this protection during good times, with the goal of earning enough to outpace inflation in years when the market is up—in effect trying to create insurance that you get paid to own. Mutiny takes a multistrategy approach. This approach hopes to offer broader and more effective protection against the many types of tail risk or black swan events that can take place, leaving the ensemble better positioned than a single tail risk strategy may be, while also limiting the premium paid and improving performance when times are good.
The best portfolios are diversified; they have some assets that go up when markets go up and some assets that go up when markets go down. This increases their long-term return. We are already finding interest from a wide range of groups including:. If you are interested in getting more information and staying up to date with the ongoing research releases, please click here. Though most people are not aware, we are almost all brought up as turkeys.
We are taught ways of thinking based on a different world. Do you have any particular questions about tail risk or black swans in financial markets? Last Updated on June 30, by Taylor Pearson. Futures and options trading involves a substantial risk of loss. You should therefore carefully consider whether such trading is appropriate for you in light of your financial condition. Unless distinctly noted otherwise, the data and graphs included herein are intended to be mere examples and exhibits of the topic discussed, are for educational and illustrative purposes only, and do not represent trading in actual accounts.
Opinions expressed are that of the author. The mention of specific asset class performance i. And further, that there can be limitations and biases to indices such as survivorship, self-reporting, and instant history. Any offer or solicitation of the Fund may be made only by delivery of the Memorandum. Before making any investment in the Fund, you should thoroughly review the Memorandum with your professional advisor s to determine whether an investment in the Fund is suitable for you in light of your investment objectives and financial situation.
The Memorandum contains important information concerning risk factors, including a more comprehensive description of the risks and other material aspects of an investment in the Fund, and should be read carefully before any decision to invest is made.
Browse the full archives below. Image credit: Antifragile, Nassim Nicholas Taleb After 1, days, Tom projects that there are two possible futures: Life gets much, much better Life gets much better. Many people today are turkeys. How can we build more robust careers that keep us from being turkeys at the worst possible time?
How can we build more robust businesses? And, finally, how can we build more robust, or even antifragile, portfolios? One is complicated, the other complex. Complexity is the domain of uncertainty , unknown unknowns. A component of a complex system where the future is unknowable has one of three properties: Fragile — harmed by complexity and volatility. That is, turkeys.
Robust — resilient or unaffected by complexity and volatility Antifragile — helped or benefitting from complexity and volatility The thread that has come to define all my work is understanding how to survive and thrive in a complex and uncertain world. Antifragile Investing in Traditional Markets In , I began reaching out and talking with hedge fund managers specializing in high volatility and black swan scenarios. We spent hours on the phone talking about his research every week for months.
Source: Why Alternatives To be truly diversified, investors need something that reacts positively to tail risk events like and actually benefits from volatility. Caption: The Black Swan is the term Nassim Taleb used to describe unpredictable and highly impactful events that create tail risk situations. Less popular but equally important is the notion of the white moose: when an investor continues betting on a black swan that never materializes.
Image source: Mutiny Fund What Jason realized is that investors needed to find products that benefit from tail risk events and market crises without paying so much insurance premium in good years that you miss out. I like to sleep well at night, and knowing I am effectively hedged is part of that.
Famous author and thinker Nassim Nicholas Taleb has comprehensively criticized such models as unrealistic and prone to all sorts of errors. His books include Fooled by Randomness , 2nd Ed. One of Taleb's chief contributions has been his rigorous evaluation of asymmetric or "fat tail" risk. He has made a compelling argument in favor of the idea that most change comes from huge events that are intrinsically unpredictable, i.
This was completely unexpected and, although caused by a variety of stressors in the system, was at least in part caused by program trading. Now notice the striking similarity between the stock crash and Taleb's metaphor of a turkey approaching and then arriving at Thanksgiving Day see chart below. Obviously, from the turkey's point of view there is no warning of what is coming, and the result is catastrophic for the turkey at least.
Applying Taleb's metaphor to the crash, it seems clear that fat-tail risk was not sufficiently discounted by pretty much everyone. Of course, there were a few people who actually benefited from the crash, either because of dumb luck or what Taleb calls "antifragile" characteristics in their asset allocations.
I personally did very well out of that catastrophic market collapse, as I sold a month before the drop and then bought back in during the week it bottomed. However, I was a geologist at the time, and it was clearly an example of once-in-a-lifetime dumb luck. Black Swans are often observed in nature or in the interaction of mankind with nature: e.
There is good reason to suspect that new Black Swan events could hit the markets again at any point in time. By definition this would not be an expected event, which automatically might exclude current risks that are at least partially discounted, i. However, some unpredictable chain of events that involves a combination of the aforementioned threats with new unknown factors might easily produce a new Black Swan.
So although we can't predict Black Swans, we can take note of conditions of asymmetric risk or imbalances that suggest risk is not adequately modeled. In his most recent book, Taleb describes how fragility and antifragility work mathematically, and in practical examples.
Let's use your car as an example of fragility. If you drove it into a wall at 50 mph it would cause far more damage than ten times the amount caused by running it into a wall 10 times at 5 mph. Likewise, if you jump off a building 30 feet tall, the damage done to you will be far more than that resulting from jumping three feet ten times. In fact, as Taleb points out, you most likely will be dead. If you were to chart this as a time series you would see a feature called concavity, as shown in the chart below.
The chart indicates that as the variable in question "x" increases, you experience moving downward on the curve from the spot labeled "you are here" losses that increase at a faster and faster rate, producing a line that curves inward. If you move in the opposite direction on the curve towards a lower level of the variable "x," you experience negative asymmetry, i. If instead we set out seeking the opposite of fragility or concavity, i. An investing example of this would at first glance seem to be the use of long-term Treasuries in a balanced portfolio during a recession and bear market.
The worse things get as the economy worsens and the stock market collapses, the better the Treasuries do. We will come back to discuss this example again later because it may not actually turn out to be a very good example of antifragile behavior. The theoretical depiction of an antifragile effect is shown as convexity in the second chart below; i. Under convexity antifragility , if you move in the opposite direction on the curve towards lower values of "x," you experience negative asymmetry, i.
Obviously, if it would be possible to find assets that are reliably antifragile or construct portfolios that have reliably antifragile characteristics, it would be to our benefit as investors, especially when new Black Swan events transpire or if highly asymmetric risks became prevalent and were recognized as such before an otherwise unpredictable event. There are a number of very good examples of Black Swan events in the markets that we could use as backtests of the antifragility of assets, including those already mentioned above.
Of course, there are many problems with backtesting, such as survivorship bias, the occurrence of one-off events the arrow of time effect and of course the fact that "past performance is not indicative of future returns. Even a flawed model can prove useful if all we need to see is acceleration i. If, for example, we return to the idea of using long-term bonds in a balanced portfolio as we discussed in the example above, there may be a problem with labeling long-term bonds as an antifragile asset.
If you think through the notion of the antifragility detection heuristic, it may not actually be true that bonds experience lower losses when rates or stock markets go up than the gains made when rates or stock markets go down. In the chart showing the behavior of the long-term bond in and thereafter, note that all of the relative gains made in were completely gone by We must also make allowances for the secular bull market in bonds since see chart below , which overprints long-term bond performance.
The reversal of this secular trend would presumably push bonds into a secular bear market lasting decades and this would diminish their attractiveness as hedging assets, accordingly. The antifragile behavior of a portfolio example used by Taleb seems much more likely to operate as expected. The stocks could be anything, but for purposes of argument let's say they include a clean energy stock Ormat Technologies, Inc. AWK , a robotics stock Fanuc Corp.
But if one or two of the thematic stocks in the portfolio do well over time, your upside is asymmetrically higher, possibly much higher if one of them is theoretically a big winner. In other words, it delivers convexity in its results. Of course, explaining how this works to the average client would not be a picnic because many will ask why all that cash is necessary, and why isn't that a mistake to leave so much money idle? But if the goal is antifragility, this portfolio works.
Random House, Podcast Episodes. Portfolio Management. Financial Literacy. Your Money. Personal Finance. Your Practice. Popular Courses. Table of Contents Expand. Table of Contents. What Is Anti-Fragility? Understanding Anti-Fragility. Anti-Fragility Methods. How to Become Anti-Fragile. Anti-Fragility for Businesses. Special Considerations. Anti-Fragile FAQs. Economics Macroeconomics.
Key Takeaways Anti-fragility goes beyond robustness; it means that something does not merely withstand a shock but actually improves because of it. The concept was developed by professor, former trader, and hedge fund manager Nassim Nicholas Taleb.
Taleb believes we must learn how to make our public and private lives anti-fragile, rather than simply less vulnerable to randomness and chaos. Examples include not getting into debt and avoiding optimization. In investing, Taleb proposes a "barbell strategy," that splits capital between highly safe and highly risky investment assets.
A key element of Taleb's anti-fragility is avoiding debt. Article Sources. Investopedia requires writers to use primary sources to support their work. These include white papers, government data, original reporting, and interviews with industry experts. We also reference original research from other reputable publishers where appropriate.
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Investopedia does not include all offers available in the marketplace. Related Terms. Grey Swan Definition A grey swan is an event that is possible and known, potentially extremely significant but considered not very likely to happen. Black Swan A black swan is an event that is rare, very important, and is both difficult to have predicted but is considered obvious in hindsight. Who Was Milton Friedman? Milton Friedman was a U. Understanding Efficiency Efficiency is a level of performance that uses the lowest amount of inputs to create the greatest amount of outputs.
Learn how to calculate efficiency.
The mindset required to set the bar very high for all of your investments will likely help you avoid value traps and only seek excellence. Antifragile investing is for when the markets go down. To help achieve this, the Mutiny Investment Strategy aims to limit the cost of. So how do investors create anti-fragile portfolios geared for a world of As such, they should not be construed as investment advice.