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Sovereign Wealth Funds Look To Taleb's "Black Swan" For Protection

August 24, 2010
Bill Freehling

Bill Freehling

12 followers
Nassim Nicholas Taleb’s uber-bearish views on the markets are attracting interest from overseas sovereign wealth funds, The Wall Street Journal reports this morning.

China Investment Corp. and Middle East government funds are considering an investment in Universa Investments LP, the California investment firm that Taleb founded.

Taleb, a mathematical finance scholar, is best known for his 2007 book “The Black Swan.” The main premise is that people don’t foresee events that have never occurred in history. For example people assumed that all swans were white until a black one was discovered in Australia.

In the financial markets, Taleb writes, people try to chart patterns of the past to predict the future when in reality that’s a worthless endeavor. His investment strategy is therefore to bet big on an unforeseen bearish event that would send markets into turmoil--in other words a black swan.

The strategy is primarily accomplished by buying equity puts that convey the write to sell the asset at a specified, higher price, if prices fall far enough. Investors use the strategy as a hedge.

When the strategy is wrong, Taleb-style investors lose just a little. But when it’s right they earn huge returns. When financial markets collapsed in 2008, many Universa investors reportedly doubled their money. Since then, as markets have recovered, the funds have underperformed.

The strategy isn’t only paying off for Taleb in the form of hedge fund returns. Universa charges 1.5 percent of assets under management annually and gets 20 percent of profits, like many hedge funds. If the investments come through from the sovereign wealth funds, Universa’s assets could swell to $10 billion, the WSJ reports. That would mean $150 million in management fees a year alone.

In that sense Taleb is a bit hypocritical. He writes in his previous book “Fooled by Randomness” that most mutual fund managers don’t outperform the market, yet they charge investors high fees anyway. Is it possible that Taleb’s 2008 correct bet was just lucky and the sovereign wealth funds are fooled by the randomness of it?

As for Taleb, he’s not laying all his eggs in Universa or the publishing business. His continued pessimism about an economic recovery has led him to look at investing in olive orchards, whose product is widely consumed in Taleb’s native Lebanon.

“Stocks are not a robust investment,” Taleb told the WSJ. “Make sure you have a garden that bears fruits.”

About the author:

Bill Freehling
Bill Freehling
For gurufocus.com
freehling@hotmail.com

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