- This is a risk management strategy devised and used by Mark Spitznagel and Nassim Nicholas Taleb at Universa Investments
The Strategy
- It uses Tail Risk hedging i.e. uses invest a very small portion of the Portfolio in far OTM Options.
- Most of the time, these Options expire worthless. Universa calls this bleeding
- But during a significant crash, they can generate outsized gains(ie. Explosive Downside Protection) that offset losses in the long portfolio.
The Philosophy
There are 3 core principles:
- The future is fundamentally unpredictable.
- Major Events(Black Swans) are extremely difficult to predict.
- Rather than trying to predict crashes, assume that these may occur anytime and build a system that survives and capitalizes on it.
- Extreme events are underappreciated and underpriced.
- Traditional risk models underestimate rare, high-impact events.
- Most investors focus on normal market fluctuations and ignore Tail-Risks.
- Accordingly markets often underprice them and protection against them can be relatively cheap.
- Avoiding large losses matters more than accumulating small gains.
- Losing 50% requires a subsequent 100% gain just to break even.
- Therefore, protecting against catastrophic losses is more important than maximizing short-term returns
The Result
- In 2020, Business Insider reported that documents from an Ernst & Young audit summary showed Universa’s Black Swan Protection Protocol Fund generated an average annual return on invested capital of 105.2% from 2008 through 2019.
- The gains came from systematically going Long Volatility with a small portion of the capital(unlike Short Volatility strategy used by LJM Partners which eventually shuttered due vol spike during the Feb 2018 Volmageddon)