As the Japanese would say, we are flattered and humbled that Nassim Nicholas Taleb, of The Black Swan and generally, the odds of Bad Things happening fame, is promoting our fundraiser (hint: the Tip Jar is over there):
To repeat, NakedCapitalism does real journalism, while other outlets spread opinions. https://t.co/bsoKVvD9Vz
— Nassim Nicholas Taleb (@nntaleb) September 26, 2020
And our work generally:
Yves Smith is doing the job no journalist does anymore.https://t.co/w20AKVXyvQ
— Nassim Nicholas Taleb (@nntaleb) August 6, 2020
In case you’ve managed not to encounter Taleb’s writings or presentations, the “humbled” part is sincere.
Since Taleb’s signature is to suffer no fools, we recognize that our being on his Approved list is very much provisional, that if we were to write something wrongheaded that came across his radar, we’d be subject to a massive downgrade. So help give us the resources to keep doing our usual thorough job by contributing via our Tip Jar.
Earlier this year, we pinged Taleb about our frustration with how CalPERS was trying to ‘splain its way out of having given up $1 billion, which is a serious sin for any investor but even more so for CalPERS by virtue of its serious underfunding. CalPERS’ recently-hired Chief Investment Office Ben Meng had dumped two tail risk hedges just before they would have paid off. Perversely, most accounts of his demise skip over the tail risk hedge fiasco.
While investors can have bad results despite making sensible decisions, as you’ll soon see, this incident showed that Meng was not up to the job.
Taleb is an advisor to Universa, the manager of the bigger tail risk hedge which would have generated $1 billion to CalPERS, so he would clearly be familiar with the CalPERS fiasco.
Taleb not only responded quickly, including “I love your blog (actually newsletter).” but a few days late sent us exclusive video where he debunked then CalPERS Chief Investment Officer Ben Meng’s dubious defense of his actions.
In this segment, Taleb takes apart claims that Meng made in CalPERS webcast, and later in the press, that CalPERS had better hedges than the Universa hedge. Meng asserted they’d delivered $11 billion in gains during the March market rout. Taleb disputed the idea that these investments could be considered hedges, since they’d previously lost $30 billion in the previous year, thus leaving CalPERS $19 billion worse off.
Please read the earlier post in full for more detail on Meng’s justifications and why they didn’t hold water.
This misunderstanding of tail risk hedges is such an important issue that the Taleb-Meng dustup generated a follow-up story in Institutional Investor last week. Key parts:
Taleb says, “What Universa is doing is allowing people to stay in the game long enough to gather alpha. It’s not a luxury. It is a necessity,” he says in an interview. “How many people in the United States own a house without insurance on the house? The way they [critics of tail hedging] look at it, you won’t buy a house if the insurance is expensive. No, you would buy a smaller house. Insurance is not an option.”…
[Mark] Spitznagel wasn’t surprised when Meng ended CalPERS’ tail-risk hedging program. He had seen such decisions many times before. As the founder and president of Universa, he knows his products require investors to go up against modern portfolio theory and the other orthodoxy they learn in business school and starter finance jobs.
Pension funds’ first line of defense against crashes is diversification away from stocks into bonds and other assets. Second, they can opt for products or strategies like trend-following commodity trading advisers or gold. Ron Lagnado, who led the implementation of the tail hedge at CalPERS and is now the director of research at Universa, says, “I’ve written on the failure of diversification. With each big drawdown in the stock market, we see less and less protection coming from bonds. One of the reasons that pensions are so poorly funded is they have maintained such large allocations to bonds and other forms of risk mitigation, which are a drag on performance.”
We wrote at length in ECONNED about how orthodox finance theory was fundamentally flawed, particularly in how it led investors to underestimate market risk. As the quote above showed, conventional approaches in finance have also failed to acknowledge that returns among different types of investments are more correlated than in the past, which is why they aren’t as effective as they used to be in reducing risk. But managing pensions isn’t about maximizing returns; it’s about liability avoidance, which means trustees will almost always follow what their consultants recommend, and the big consultants adhere closely to well-established conventions even when they can be shown not to work well.
Our final line in our April post on Meng’s tail risk hedge screw-up:
Meng is too dishonest, top to bottom, to continue in an executive role. He need to go.
That view has proven to be correct, sooner than we expected. Being early and right is another reason to give generously via our Tip Jar!