Investor Who Returns 4,000% in Q1 2020 Explains What People Are Wrong About Mitigating Risk

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Hedge fund manager Mark Spitznagel, founder of the $ 11 billion “Black Swan” hedge fund Universa Investments, says investors misunderstood risk mitigation from the start.

“Our goals are even wrong. And really, we have modern portfolio theory to thank us for that. But it’s just kind of an investment heuristic that you have to take more risk in order to get higher returns. , in order to get more wealth at the end of the day. And as you take less risk, your returns will go down, “Spitznagel told Yahoo Finance Presents in a rare interview to discuss his second book,” Safe Haven : Investing for Financial Storms ”, which he describes as his company’s“ manifesto ”.

The safe-haven 50-year-old professional investor said, “The risk mitigation goal, like the investment goal, should be to increase our cap rate over time,” which he adds. -it, “goes against everything we know about modern finance.”

This is what Spitznagel dubbed the “great risk dilemma”, where if an investor doesn’t take enough risk it will likely cost him his wealth over time, and if he takes too much risk it will cost him. probably also its wealth. overtime.

While many have this idea that risk mitigation is often a trade-off against wealth creation, Spitznagel demonstrates that “there really is another way” to profitably reduce a portfolio’s risk and be additive. over time, thus increasing the CAGR of a portfolio.

Spitznagel is among the most successful investment managers of the past decade and more, reaping huge gains in stock market crashes. At the height of the COVID-19 pandemic last year, Universa delivered a staggering 4.144% return in the first quarter, when markets sold off strongly.

Businessman checking stock market data. He uses a cell phone. Analysis of economic data on the forex earnings chart.

According to documents reviewed by Yahoo Finance, the to-date average annual return on invested capital from the fund’s inception 11 years ago until the end of 2019 is north of 105%, making Universa one of the best performing hedge funds during this period. time. Today, Universa manages nearly $ 11 billion in assets under management, nearly triple what it had at the end of 2020, according to documents.

As Spitznagel notes in the book, the performance of Universa’s sub-risk portfolios is “a direct consequence of having much less risk.”

Universa Investments specializes in risk mitigation, by deploying a extreme risk coverage strategy for limiting losses from a disproportionate market event, such as a “Black Swan”. Nassim Nicholas Taleb, author of “The black swan, “is the” Distinguished Scientific Advisor “of Universa Investments.

“[The] The way Universa invests is probably the most bearish expression one can have as an investor. And yet, at the same time, my clients want the markets to go up, ”Spitznagel said.

Put simply, the back cover acts like insurance with asymmetric and explosive downside protection. Spitznagel is known to take small expected losses over time and make big profits in the event of a crash.

Spitznagel, who grew up as a “shabby, poor kid,” in Chicago’s commodity trading pits, said it was there he learned from a mentor that “a little loss is a good one. loss “.

“And as a pit trader that’s kind of what I was taught, really starting as a teenager, that this is what trading is – trading takes very small losses and takes very big profits, “said Spitznagel, stressing that this is” diametrically opposed to the way just about all hedge funds operate. “

While Universa’s returns, like the 4,000% return in Q1 2020, often attract media attention during crashes and massive sell-offs, Spitznagel said he “always likes to stress it less.”

“[Because] really, at the end of the day, any bettor can design a trade that works well in a crash. The key is to know how to make in the event of an accident a gain similar to that of an insurance like that of Universa. How do you deal with a crash compared to the rest of the time? So that’s really what matters, it’s those long periods of time that really matter, ”the investor added.

Regarding the state of the markets, Spitznagel is of the opinion that the Federal Reserve “is manipulating the most important information parameter of the economy, and it is interest rates”, which “rocks” as well. the homeostatic system of financial markets. , which he notes as a “corrective feedback mechanism”.

But I would say that doesn’t remove it. It kind of delays it and focuses it in time. So I think a good way to think about that is when you’re driving, driving is really that kind of feedback mechanism where you make those minor corrections. And I think that’s a good way to think about what the market is doing, the pricing system. But think when you are driving on the ice all of a sudden you have this delayed feedback so that when you do something nothing happens until it happens all of a sudden, ”he said. added Spitznagel.

He points out that history shows that the homeostatic corrective feedback mechanism “shows the angry head, and that’s really what a crash is.”

“But it is aggravated and delayed by this interventionism of the central bank”, he added.

True, Spitznagel says he remains “very agnostic about all of this”.

“[I] thinks it is important to invest in such a way that you do not rely on these kinds of grandiose forecasts. I think it’s a misnomer when people think investing is forecasting. I think in general everyone agrees. But it really shouldn’t be a forecast, ”he added.

Spitznagel pointed out that the range of results is huge and you only have one way to trade.

“We don’t get an average across all possible paths in the multiverse. We only get one. So it’s kinda crazy to invest based on that,” he added. .

While Spitznagel has an exception to “some destruction in the future in the financial markets, that doesn’t necessarily mean someone should just go into hiding as that in and of itself might not be the best strategy either.” .

“It’s a bit like the dogma of diversification, to think that just reducing your risk will be better for you. People need to think about it more carefully,” he added.

Julia La Roche is a correspondent at Yahoo Finance. Follow her on Twitter.

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