Black Swan hedge-fund Universa Investments LP, advised by The Black Swan author Nassim Nicholas Taleb, has recently profited more than $1 billion on a option shorting strategy that profits when financial markets melt down.
According to a Wall Street Journal source, Universa Investments was up close to 20% on the recent Black Monday, a trading session where the Dow Jones Industrial Average was off over 1,000 points, before recovering to finish down 588 points on the day.
The sources noted that Universa Investments’ returns for the year topped 20% as of earlier this week. Universa invests in positions designed to hedge close $6 billion in client assets. It is unclear from the Journal article how many of those gains were realized and if they were lost
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Statement from Universa Investments founder Mark Spitznagel
“This is just the beginning,” commented Universa founder Mark Spitznagel, in reference to recent market volatility. Spitznagel’s ongtime collaborator Taleb, who advises Universa, is a professor at New York University and had become famous for his negative forecasts on the global economy.
“The markets are overvalued to the tune of 50%, and I’ve been saying that for some time,” noted Spitznagel, who has been calling for a global stock correction relating to the “easy-money” policies by central banks around the world for some years now.
WSJ describes Universa Investments strategy as follows:
The firm focuses on finding cheap, shorter-dated options on the S&P 500 and other instruments it expects to rise in value amid a notable downturn. During the past week, the value of put options that Universa bought over the past one to two months jumped, said people familiar with the matter. A put option confers the right, but not the obligation, to sell a security at a specified price, usually within a limited period.
In a Bloomberg Brief interview earlier this year Mark Spitznagel, summarized Universa Investments strategy as follows:
I’m probably the most bearish professional investor you will ever talk to. Yet my clients use me to get and stay long the stock market. It’s a little bit counterintuitive. My strategy makes a lot for a portfolio when the market crashes and it doesn’t really do much of anything for a portfolio when the market rallies.
Q: How exactly do you do that?
A: You could summarize it by saying we own a lot of out-of-the-money puts on stock indices. That’s the dominant position in a crash, the tail hedge. But the devil is in the details. There are a lot of things we do to not burn through the cost of those positions every time the market doesn’t crash. I’m arbing the volatility surface, selling things that are expensive against buying things that are cheap. But what’s important is how our strategy completely transforms an entire portfolio. When you start off with a 60-40 stock-bond allocation, for instance, and you add a tail hedge, now you can move to a 90-8-2, stocks-bonds-tail hedge, and you’ve actually lowered your risk. Traditional asset-allocation becomes a false choice. The way I think about it is, my clients become responsibly long as opposed to just long. And when the crash comes, the tail hedge cancels out the stock losses and provides the liquidity to buy when everything becomes cheap.
Universa Investments: More on Black Swan hedge funds
Short-focused investors such as Universa and other Black Swan hedge funds look to make big money from large market downturns, and these have done very well the last coupleof weeks as global markets have plunged.
These funds “so far this month have been very strong,” points out Gregg Hymowitz, founder of hedge-fund investor EnTrust Capital Inc., who has invested in Blck Swan funds for around four years. “If your house burns down, you want to have some protection.” Allocators generally place a small sum of assets in these funds as they are mant to provide protection not long term capital appreciation.
The name the long-held belief that all swans are white, which was eventually proven to be not true when Europeans found black swans in Australia. A Black Swan event in the finance sector refers an extreme and highly unexpected occurrence (the exact definition of Black Swan requires some more elaboration and is beyond the scope of this article) such as an extreme financial crisis. Taleb first popularized the term in his best-selling 2007 book describing the crisis. Taleb is also popular for his witty commentary on twitter regarding risk management, politics, wine, GMOs, among other topics.
@amine_ouazad This is imbecilic. Statistics is NOT about inventing certainties but understanding and uncovering uncertainties. Imbecilic.
— NassimNicholasTaleb (@nntaleb) August 30, 2015
In a speech given Taleb the day this WSJ story broke, Taleb spoke about tail risks and black swans at The Fletcher School. Taleb noted that banks in both 1982 and 2007/08 lost more money then in the history of banking. Taleb noted that many of the problems at banks were caused by faulty risk management related to VAR.
A few hedge funds saw double-digit percentage gains in the last week or so. A reliable sources says that Capstone Investment Advisors is up 52%, or around $100 million, for August as of Wednesday, most of it resulting from gains last Friday through Tuesday. Black Eyrar, a fund owned by 36 South Capital Advisors, was up in the double digits for August through last Friday, according to a knowledgeable WSJ source. Another short-focused fund at Boaz Weinstein’s Saba Capital Management jumped 14% for August as of last Friday, but that just brought its returns up from negative to +1% for the year.
Readers can find some recent research papers from Universa Investments here