Is there an investment strategy that fits with the
I will get there. Let me make some investment rules in
Number 1: I introduced earlier the 1/n rule-be as broad
as you can in whatever risky assets you are investing in to
minimize the risk.
The second trick, or rule, [is to] implement that barbell
to reduce your fragility. Because if you see the barbell,
then no fragility is in the tail. In other words, if you are
"bar- belied," putting a floor on your losses at 90%, the
maximum you could lose is 10%. If the markets go down 20%,
you don't lose twice as much as [you would] if the market
went down 10%. You lose much less. That puts you in the
antifragile category. [For a third rule] I'd say, look for
companies that have optionality.
What is optionality?
Optionality means to have more upside than downside
because the company has options. An "option" in this sense
acts like a financial option, and a financial option is an
instrument of antifragility because you pay a premium and you
have all this upside and very little downside.
The companies make more from the upside of something than
from the downside. Make sure the optionality is not priced by
the market. And of course, go away from companies that have
An optionality that is priced in the market is, for
example, buying energy companies and gold companies before a
rally in gold. Instead of investing in gold, people invested
in companies that made a lot more than gold. But after a
while, this got priced in. In other words, if you're wrong on
gold, you do a lot better than those who invested in gold
outright. If you're right on gold, you do a lot better than
those who invested in gold.
You have to avoid the lottery-ticket effect of investing
in companies that are overpriced because people are looking
at the big upside.
So, now we have three rules [1/n, implement the barbell,
and pursue optionality].
Let me make one more-never invest in company stocks or
strategies that have very low volatility without ascertaining
that there's a floor on the return.
[Consider that] a Sharpe ratio measures return divided by
risk, as measured by past variation. You have to be wary of
companies that exhibit no volatility yet have a high return,
unless they are genuinely low volatility. Most of them are
fake low volatility.
What do you mean by "fake low volatility?
You know the funds of Bear Stearns that blew up in the
subprime crisis? They were funds that never had a down month.
A lot of people who blew up in subprime did not have a down
month-ever. And people rushed to invest in them because they
were low volatility. And then they blew up.
Typically, I never get close to anything that has no
volatility, unless it's justified, like Treasury bonds. If
you go to a balance sheet, you can see why there is low
volatility, whether it is genuine. The company can have a
barbell. The company can have very, very low leverage. Or you
might discover that a company is doing the equivalent of
selling remote options, and the company can lose a lot of
money in one blow.
Let's link it to make it more intuitive: In general, I
can say that a system that has very, very low volatility is
likely to blow up. Take the example of Syria. Syria had no
political volatility for 40 years, and look what
Forests that never have fires are likely to be completely
eradicated by fires when they happen. Forests that have
regular fires are much more stable.
You mentioned the concept of leverage. You could
make another investment rule regarding debt?
Yes. You know the rule-what you don't do is more
important than what you do. In natural systems, you need
redundancy to make the system work better. People think that
redundancies are inefficient. I think they're the most
efficient thing in the world, if you do them right.
Redundancy is bad if you buy the same morning newspaper
twice or if you have two subscriptions to the same website.
But redundancy is fine if you have a stock of cash in the
bank or if you're a company that needs oil and you have extra
Let's assume that you have cash in the bank and there's a
big crisis. You have dry powder. It will make you antifragile
to have the extra dry powder if nobody else has money. You
can buy anything you want. Cash is the opposite of
In fact, the number one indicator of fragility is
leverage. It can be operational or financial. Leverage
corresponds to people's overconfidence about the future.
Most people who have leverage will be completely squeezed
in a crisis, and you will have cash.
Whose compensation models do you agree
Most investment advisers are not harmed by the downside.
The only people who have a good compensation model are hedge
fund managers. Typically, when I managed money, I was harmed
50 times more than any of my clients as a percentage of my
The hedge fund managers I know are typically far more
invested than their average client. When that person is on
board calling the shots, I sleep like a baby. You don't get
this with fund managers.