Equity markets around the world are hitting fresh lows almost daily, while many countries globally are expected to slip into recession, thanks to the coronavirus outbreak. Despite such troubling times, one Black Swan hedge fund (Universa Investments of Mark Spitznagel) reported a return of more than 4,000% in the last quarter, thanks largely to their unusual investment strategy.
Universa Investments: how it performed?
In a client letter reviewed by ValueWalk, Universa Investments noted that investors in its Black Swan Protection Protocol (BSPP) strategy witnessed a net return of 3,612% on capital in March, based on required invested capital at the start of the year. The fund’s year-to-date net return on capital is even more at 4,144%.
Universa Investments specializes in convex tail hedging and investing. Such investing strategy helps to limit losses or even profits from market shocks, such as the coronavirus. Or, we could say, the tail hedge works like insurance for portfolios.
Top value fund managers are ready for the small cap bear market to be done
This is not the first time Universa Investments (Mark Spitznagel) has made a massive return during turbulent times. As per the WSJ, Universa made 20% in August 2015 when the Dow lost more than 1,000 points. Since the inception of the fund, the investors have witnessed a net return of 239% on capital.
Mark Spitznagel, who founded Universa Investments, is also its President and Chief Investment Officer. “When the market crashes, I want to make a whole lot and when the market doesn’t crash, I want to lose a teeny, teeny amount,” he said. “I want that asymmetry... that convexity,” he said.
Mark Spitznagel is a protégé of Nassim Nicholas Taleb, who is the author of the 2007 bestseller The Black Swan. Black Swan is a term used for unpredictable, highly disruptive events that could create havoc in the financial markets. Previously, Spitznagel worked at Taleb's Empirica Capital, which is closed now. Taleb now is Universa's scientific adviser.
Not an investment strategy, but insurance
To benefit from one-time events, Spitznagel depends on far out-of-the-money “explosive downside protection” bets. In simple words, we can say that the expert bears small losses for years in anticipation of the market crash.
According to Spitznagel, the fund managed to cash-in and made gains from many of their positions. Along with cashing in, they also ensured protection from further equity sell-offs.
Universa Investments does not see its tail-risk hedging as an investment strategy. Instead, they tell investors to consider it as catastrophe insurance. This allows them to be more aggressive in their hunt for return without depending on the usual risk mitigation strategies, such as diversification, adding treasuries, gold or hedge funds.
Such a strategy has certainly paid off. However, the strategy must not be seen as one that could earn you a healthy return but rather as a risk mitigating part of the bigger strategy. To explain this, Spitznagel included a chart in his letter, according to Bloomberg.
As per the chart, a portfolio that has invested 96.7% in the S&P 500 and just 3.3% in Universa’s fund would have been unscathed in March, when the S&P was down 12.4%. The same portfolio would have earned a return of 11.5% a year since March 2008, compared to 7.9% for the index.
“Anyone can make money in a crash; it’s what they do the rest of the time that matters,” Spitznagel wrote. “The totality of the payoff is what creates the portfolio effect.”
Mark Spitznagel on what lies ahead
Going forward, the expert believes that the easy availability of money from the banks would air the bubble that will eventually result in a major global reversal. “If the pandemic doesn’t pop this bubble then, of course, it will be something else that eventually accomplishes this,” Spitznagel said in the letter.
Talking about the markets, Spitznagel points at high valuations noting they (markets) are “very much trapped in the mother of all global financial bubbles."
Similar comments were made by Spitznagel last month after a great month for the fund in February. "For people who are worried about having missed it, this sell-off has only taken back a few months of gains," he said, according to the WSJ. "I expect a true crash to take back a decade."
Even Spitznagel admits that there are no “magic crystal balls” to know about the market crash or bubble popping beforehand. “Sure, the global pandemic risks were there for all to see... but no one can ever really see what’s next, what lies around the corner,” Spitznagel wrote in the letter. “Despite our performance, that has included us. One’s risk mitigation strategy must reflect that reality.”
Taleb, in a recent interview to Bloomberg Television, said that a pandemic, such as coronavirus, was predictable. Thus, the investors who were not hedged experienced heavy losses. Though such events can be predicted, what, according to Taleb, is impossible to predict is the timing of such an event. That is why insurance (hedging) is a must for investors.