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Investor who returned 4,000% in Q1 2020 explains what people get wrong about risk mitigation
Finance

Investor who returned 4,000% in Q1 2020 explains what people get wrong about risk mitigation

Mark Spitznagel (hedge fund manager), is the founder of $11B “Black Swan” hedge-fund Universa Investments. He says that investors have been mistaking risk mitigation from the beginning.

“Our goals are even incorrect. Modern Portfolio Theory is the reason. It’s just a way of investing. To get more wealth, you must take on more risk. Your returns will decrease if you take less risk,” Spitznagel said to Yahoo Finance Presents in rare interview. He was talking about his second book, Safe Haven: Investing for Financial Storms, which he described as the “manifesto” of his firm.

A professional safe-haven investor of 50 years old said that “the goal of risk mitigation, just like the goal for investing, should be raising our rate of compounding over the time.” He added that this “flies in front of everything we know about modern finance.”

This is what Spitznagel calls the “great dilemma and risk”, where investors who take too many risks will most likely lose their wealth over time.

Many believe that risk mitigation is a trade-off for wealth creation. However, Spitznagel shows that there is a cost-effective way to lower portfolio risk while increasing portfolio’s CAGR.

Spitznagel has been one of the most successful investment managers over the past decade, raking in huge gains even during market crashes. Universa posted a remarkable 4,144% return in the first quarter of last year’s COVID-19 pandemic.

Yahoo Finance documents show that Universa is one of the most successful hedge funds of all time. The fund’s average annual return on invested capital between 11 years ago and the end of 2019 was north of 105%. Documents show that Universa has close to $11 Billion in assets under management today, which is almost three times the amount it had at its end of 2020.

Spitznagel explains in the book that Universa’s performance with risk-mitigated portfolios is “a direct result of having far more risk.”

Universa Investments specializes on risk mitigation. They use a tail-risk hedging approach to minimize losses from a large market event like a Black Swan. Universa Investments’ “Distinguished Scientific Advisor” is Nassim Nicholas Taleb. He is the author of “The Black Swan.”

“Universa’s investment strategy is probably the most bearish one can use as an investor. Spitznagel stated that my clients still want the markets to rise.

The tail hedge is insurance that provides explosive and asymmetric downside protection. Spitznagel is well-known for absorbing small losses over time and making large profit in a crash.

Spitznagel, who was a “scrappy and poor” child in Chicago’s commodities trading pits, stated that he learned from his mentor that “a small loss can be a big loss.”

Spitznagel stated that trading is “diametrically opposed” to how most hedge funds operate.

Spitznagel stated that Universa’s returns, such as the 4,000% return in quarter one of 2020, are often the focus of media attention during crashes or sell-offs. However, he said he prefers to “de-emphasize” those returns.

“Because, really, any punter could devise a trade which does well in a crash. How do you make a crash payoff that is similar to Universa’s? What is your performance in a crash compared to other times? The investor said that this is what really matters. It’s these long stretches of time that really matter.”

Spitznagel believes that the Federal Reserve manipulates the most important information parameter of the economy, that is, the interest rates. This “rips apart the homeostatic system” of the financial market, which he says is a “corrective feedback device.”

It doesn’t eliminate it, however. It merely delays the process and makes it more concentrated in time. This is why I believe that driving is a feedback mechanism, where you make minor adjustments. This is a great way to see the relationship between the market and the price system. Think about it, when you drive on ice, you suddenly have delayed feedback. This means that you don’t know what will happen until it does.

He says history has shown that the homeostatic correctional feedback mechanism “rears it’s angry head” and that that is what a crash really is.

He said, “But it’s worsened and it’s been delayed through this central banking interventionism.”

Spitznagel is certain that he remains “very much an agnostic” to all of it.

“It’s important not to rely on grandiose forecasts when investing. It’s wrong to think that investing is all about forecasting. That is something that I believe everyone agrees on. He said that forecasting is not the right thing.

Spitznagel stressed that there are many outcomes and only one way to trade.

“We don’t get an average across all paths in the multiverse. We only get one. He said that it was a bit crazy to make an investment based on this one.

Spitznagel does have an exception for “some destruction in future financial markets”, but that doesn’t mean someone should hide away. That in and of its own may not be the best strategy.

“That’s kinda like the dogma diversification, which says that lowering your risk will make it better for you. He said that people need to consider this more carefully.

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