Monday, June 1, 2009

Taleb Makes Hyperinflation Bet and Why You Might Want to Be Skeptical

Update here.
Original post:
Be careful!
The first point to be made is This is NOT a Black Swan bet. Black Swan's by definition come out of the blue. Inflation caused by central bank monetary and government fiscal policy is being debated in the HEADLINES!
Second, and more specific, Mr. Taleb is a better marketer than a money manager. His hedge fund returns were opaque* (which considering his self promotion implies they weren't that hot).
First though, the story by Scott Patterson at the Wall Street Journal (emphasis mine):

A hedge fund firm that reaped huge rewards betting against the market last year is about to open a fund premised on another wager: that the massive stimulus efforts of global governments will lead to hyperinflation.

The firm, Universa Investments L.P., is known for its ties to gloomy investor Nassim Nicholas Taleb, author of the 2007 bestseller "The Black Swan," which describes the impact of extreme events on the world and financial markets.

Funds run by Universa, which is managed and owned by Mr. Taleb's long-time collaborator Mark Spitznagel, last year gained more than 100% thanks to its bearish bets. Universa now runs about $6 billion, up from the $300 million it began with in January 2007. Earlier this year, Mr. Spitznagel closed several funds to new investors.

Unlike last year's sudden market implosion, inflation isn't an unimaginable event that few currently anticipate. In fact, many fear inflation right now amid government efforts to goose the economy. Universa's bet, however, is that inflation will reach levels few expect.

By opening the inflation fund, Universa is trying to capitalize on a wave of investor demand for its products, which when they're right can protect investors from extreme market moves....

...For the new inflation fund, there are risks.

As investors, Messrs. Spitznagel and Taleb have a mixed track record. The two managers wound down their Empirica Capital fund in 2004 after several years of lackluster returns.

Also, some investors are worried not about inflation but about deflation and its pernicious effects were the economy to remain stalled.

David Rosenberg, chief economist at Gluskin Sheff, a Toronto wealth-management firm, believes inflation won't take hold until consumer spending rebounds, which he thinks could take years. Says Mr. Rosenberg: "Not until the household sector expands its balance sheets are we likely to see the re-emergence of inflation on a sustained basis."

Mr. Taleb said any deflation would be matched by an aggressive move by governments to stimulate their economies, leading inevitably to an uncontrollable surge in prices....MORE

Nassim Taleb is a former trader who wrote a textbook on option and market making, and then became more philosophical in his best seller Fooled by Randomness, and now in The Black Swan. His big idea is that sometimes, unexpecting things happen: countries dissolve into anarchy, wars start, unknown authors become famous. His secondary ideas are variations on this theme, that people, especially experts, are generally biased, overconfident, and rationalize past event so they appear deterministic. Stated baldly, these assertion are hardly novel but true enough, and one can argue about their relevance in various cases. As a highly popular presentation of ideas near to my interests and vocation, I think it is worth critically examining if there is anything to his particular contribution to the literature on cognitive biases or social failures. My conclusion, in short, is no.

Taleb’s style is to severely criticize experts and authorities--lots of 'moron', 'idiots', and 'fools' out there--while implying that both he and his reader or listener are exempt from their many biases. Reading someone deflating puffed-up egos, criticizing the insular world of academics, and suggesting the experts have a huge blind spot on something important, can be fun reading. But it has to be making points that are true if new, or important if true, and here he fails to deliver....MUCH MORE

*Here's Mr. Falkenstein at the Wilmott message board:

...He also states that things with 'wild risk' have good risk-return characteristics, but I think the evidence there is in the opposite direction, and Taleb offers nothing but anecdotes for his assertion. Indeed, the implication is to buy out of the money options, because people underestimate catastrophes and their opposite, implies a straightforward investment strategy, which has been tried, by, well, Taleb.

As per the WSJ publishing his track record, why not mention the Sharpe then? I will write a check to Taleb for $1000 if Empirica Kurtosis LLC, his flagship fund, generated a Sharpe greater that 0.75 from Jan 2000 through November 2003 (its life). Just show the audited returns, profits and assets under management. I do not think it is plausible that a plus 1.0 Sharp strategy was shut down because the founder or owner was busy, so I am offering him some leeway. But the offer stands....MORE
If the fund was closed after four years, I'd guess it wasn't due to overperformance. I can't find any results for Mr. Taleb in 2005, 2006 or 2007.
Here's more Falkenstein, from March this year:
And then there's his hedge fund, Empirica Kurtosis, a fund he ran for 5 years, from 2000 through 2004. There was a joke when I was at one fund, where a bad idiosyncratic trade is always called a 'hedge' after the fact. That is, the money you lost on that punt on volatility, or the oil bet you made that goes against you, you say was hedging something else in your portfolio. It's a nice way to explain away a bad idea. So after the fund starting grinding out losses, Nassim started calling his fund a 'hedge', not a fund, later, a 'laboratory'. Now he says about the fund:
`Our aim was not to make money,'' Taleb says. ``I make no claims of being able to beat markets.'
But he makes sure any article that mentions his fund notes he made 60% in 2000. The only record of his total fund was a WSJ article on him in 2007, which notes he lost money in 2001 and 2002, made single digits in 2003 and 2004. That averages out to around 12%, and as the risk free rate was about 4% over that period, and the volatility was probably around 17% on a monthly basis, thats a Sharpe of 0.47. Not so good. And that's with his unaudited returns, so it's probably biased high (people have a tendency to round unaudited results upward significantly)....MORE
And from a commenter on that post:
Did you happen to see this recent interview with Taleb?

I think my favorite part was this:
Did your personal portfolio benefit or suffer from the subprime crisis?
I prefer not to answer that, as I am trying to avoid talking about my nonintellectual activities. .

That's Taleb, Mr. Discreet. Link via Free Exchange , which unbelivably starts its post with this:
“RISK GURU” Nassim Taleb saw the current financial crisis coming. He anticipated it; while those on the street stayed ignorant, taking false comfort in their models of risk.
Just be careful of celebrity market commentary.
The strongest correlation between a prediction and it's accuracy is the celebrity of the predictor.
As you've probably guessed, the correlation is negative.