Swan Song
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Swan Song
First he was very famous, now he's very rich. But Nassim Taleb is still wrong.
By Mark Gimein
Posted Monday, June 15, 2009 - 2:16pm
While for just about everyone involved in the markets the last two years of financial history have been a massacre, they have been a long victory lap for Nassim Nicholas Taleb. Taleb is the author of The Black Swan, the book about, as the subtitle puts it, "The Impact of the Highly Improbable." It came out in 2007, just before everything that seemed highly improbable became painfully actual. As everyone else's fortunes have shrunk, Taleb's have risen. Not only have his books made him the public face of the New Catastrophism, but his insights have turned out to be extremely profitable: The Wall Street Journal reports that Universa, a hedge fund for which Taleb serves as guru and adviser, gained more than 100 percent last year and now holds $6 billion.
It's hard to argue with success. In bubble markets and bear markets, the talk always turns to new paradigms. If there was a huge crash yesterday, why shouldn't there be an even bigger one tomorrow? For a while now, though, I've been trying to explain to people why I am loath to jump on the Taleb bandwagon. The news about Universa doesn't change this. I am not surprised that Taleb's approach has made money for investors. But I will be if—assuming he doesn't change his approach—he keeps doing so.
Taleb has become the go-to philosopher of the markets with a straightforward and appealing precept: that people always underestimate the chances of improbable, out-of-the-ordinary events. This to me seems a dangerous proposition about the markets. It is also, I think, a questionable proposition about human behavior.
While Taleb has acquired a huge following in the world of business and investment, he does not present himself mainly as a "business" thinker. Little of his 2004 book, Fooled by Randomness, and even less of The Black Swan talks about investing directly. His conceit is that he helps readers see possibility. It is attractive because it separates people into the plodders—or, as Taleb calls them, nerds—and the street-smart Talebites who've learned to appreciate the unexpected. But the closer you look, the less clear it is that the plodders are as consistently wrong as Taleb thinks.
One thing to be said in Taleb's favor is that he has never lost a spectacular amount of money at once. Three times now he has made money when few others did. The first was in the 1987 Black Monday stock market crash, when he made $35 million to $40 million as a trader. The second was the tech stock crash of 2000, when Taleb's own fund, Empirica, gained 60 percent. And the third is Universa.
What you might miss in this, though, is what happened to Taleb in the in-between years. Taleb, in the pre-Universa days, said that his Black Monday windfall made up 97 percent of the money he'd made. Afterward, he moved through several trading jobs without much success. In 1999, he started Empirica, which, as the Wall Street Journal reported, followed the gains of 2000 with several lackluster years and closed in 2004. In Taleb's telling, this is part of the magic. "When you lose money steadily and then make money in lumps," Taleb told Bloomberg magazine, "people think you're crazy."
Photograph by Carsten Koall/Getty Images.
Comments
The trouble with Talib's strategy
Taleb's strategy is reasonably obvious, which he admits. He buys options that are way out of the money and hopes for volatility. His theory, which someone needs to run the data to check, is that options far out of the money are significantly underpriced. The players who price options based on a normal (Gaussian) distribution based on the Black-Scholes model of market behavior will, Taleb claims, systematically underprice options far out on the curve. His strategy exploits this. Whether that's a correct analysis is tough to check, because you have to look at decades of data to see enough outlier events, i.e. big crashes. As Talib admits, his funds bleed in boring years, then make money during crashes. There's another problem. If you buy options that are way out of the money at a low price, can your counterparty pay up if the unlikely event happens? The AIG fiasco, the CDO market collapse, and further back,"portfolio insurance", indicates that the answer is sometimes "no".
He's got a point
I haven't read “The Black Swan” but from the discussion it is clear that the book is about"The Impact of the Highly Improbable." When everyone else's fortunes have shrunk, Taleb's have risen. The Wall Street Journal report also showed that Universa, a hedge fund for which Taleb serves as guru and adviser, gained more than 100 percent last year and now holds $6 billion. This proves that he has got a point here.
Needed info
Enjoyed reading your piece on Taleb. While I'm a big fan of his books (which are more philosophy books than anything) and generally subscribe to his views, it's always good to hear the other side. The question left unanswered by your piece, however, is just how badly did he do in the down years? If he went up 60 percent in 2000 and 100 percent just last year then he could theoretically have decades of small declines and still be well ahead of the historical average. He has always described his strategy as being willing to lose pennies at a time. I would guess since he shuttered the first hedge fund that the losses were pretty bad (maybe dimes and quarters), but still, it would have helped to know. Is that data not public? Is there not an investor available to leak a few reports?
Bleed or Blowup
Here is Taleb's academic article on the idea behind his trading strat. http://www.fooledbyrandomness.com/bleedblowup.pdf Mr. Gimein seems not to be able to understand this simple concept very well. But I think Taleb could run the risk of being a victim of his own theory, in that the market can stay irrational longer than you can stay solvent. Got to gamble somehow though.
Real life
The subject of Taleb is simple: real life can't be modelled. Suckers think it can. Don't be a sucker. In other news, registering for this site is like trying to crack a Defense Dept computer. It's only a blog. Get over yourself.
nassim
Nassim is famous because he cloaks intent with a veil of plausible deniability. He not only provides an alibi for those who profited, but his concept of randomness makes victims more likely to give up and not look too hard for answers.
Envy
It sounds like envy to me.... Taleb was not outstanding during the "normal" periods of market activity, nor was I. My returns prior to 1987, 2000 and 2008 were somewhat average. Not a shining star and many times ridiculed and scorned by many of my peers. I even had a few of my clients whom I was advising drop me in and guess what, they went with Madoff. Imagine that...... after all the money I made for them during the dot-com bust, they called me an idiot and took their money to a genius. I am happy for them. The message that NNT sends is..... "Go ahead and cross the quiet intersection, just don't do it with a blind fold on..." Pretty simple stuff, if you ask me, quite similar to the advice that my grandmother would give... Best regards, Econolicious
A testable proposition
I haven't read Taleb and I thank all the prior commentators whose expositions helped me understand the issues better.
But in the end, I wonder, hasn't anybody tested Taleb's claims vs Gemein's criticism by empirical test? If Taleb's wins and losses were converted into total return on investment over a 30 year period, would he beat or miss the returns on a market index fund?
No, you're wrong actually
I have read the article and the Black Swan book and I really do not understand Mr Gimein's argument. How you can refer to someone who not only survived but flourished during the three biggest market crashes of our generation as "wrong" is quite simply beyond me. What does it matter if he had indifferent performance during the "in-between" years when the times he got it right he got it so massively right that he could retire instantly?! Ask the average investor whether they would like to make "$35-40 million" and then have ten or fifteen years "without much success" investment wise I think they would take it. The point that the author of this article seems to miss and is a central tenet of the Black Swan philosophy is that failure is a necessary component to benefiting from these unusual, "asymmetric outcomes" that NNT has succeeded in benefiting from not once, not twice but 3 times (!) in 20 years. Do you think he might be on to something?! And while the investment advice is limited in the Black Swan (it doesn't claim to be an investment book anyway) it does lay out the central idea of keeping around 80% of your assets in safe/conservative investments, while spreading the other 20% across the riskiest investments you can find, namely private equity that can provide a huge return on a relatively small initial investment.
The main point of the book however is to simply raise the reader's conscientiousness in all walks of life, from how you gauge investment risk, to what you choose to do for a living, to how you think about terrorist attacks or work projects. It teaches you not to put your trust in the hands of the so-called "experts" with their fancy models that got us into this mess in the first place.
Mr. Gimein seems not to be
Mr. Gimein seems not to be able to understand this simple concept very well. But I think Taleb could run the risk of being a victim of his own theory - date ideas for Moz-invest