The New Robber Barons Page 14
Taleb Kills $20 Billion Mythical Swan
June 1, 2009
A recent GQ article quoted Nassim Nicholas Taleb as saying that in the falling market he “made $20 billion for our clients, half a billion for the Black Swan fund.” 1
I checked with Nassim Taleb regarding the $20 billion in gains and asked if he were misquoted. He responded via email: “The quote is inaccurate. THe [sic] 20 billion might correspond to the face value of positions.” This response is both vague and different in character from the mythical $20 billion in gains inaccurately quoted in GQ’s article. The total gains could be a tiny fraction of what Taleb loosely describes as “face value.” 2
Why is GQ’s mistake important? In my opinion, public claims of enormous private hedge fund gains require credible back up, and one would think that GQ would have known that before it inaccurately quoted Taleb as having made a bell ringing gain of $20 billion for clients. Presumably, the error referred to outside clients, not the black swan fund itself, but it could have the side effect of attracting investors to the black swan fund, similar to advertising or salesmanship.
The black swan fund’s strategy is purportedly to buy out‐of‐the‐money put options on stocks and broad market indices and hedge tail risk for clients. The strategy may produce long periods of mediocre—or even negative—returns followed by a large gain and vice versa. No one can tell you for certain exactly when (or for how long) large gains are possible. Initial success in a newly created fund may not be replicated in the future, and there is always the problem of scaling. Scaling refers to the fact that an individual fund may make a high return on an initial investment, say 100% on $100 million, but lose 10% on $1 billion.
The Market Can Stay Irrational Longer Than You Can Stay Solvent (or Patient)
We know that big unanticipated market moves always result in big winners and big losers. After the fact, many winners claim they were smart—not just lucky.
In my opinion, any claim of enormous gains for any strategy—including a black swan fund—should be explained and balanced with caveats. The siren song of enormous gains is always enticing, but the actual swan song may be off key.
A black swan fund strategy may produce future huge gains, but it may also produce mediocre returns (or even slowly burn cash for long periods) before producing another huge gain. The waiting period for the next big payday could be brief, or it could be longer than your investment horizon.
Endnote: On June 3, 2009 I sent this to Taleb to give him a chance to respond to my commentaries if he chose to do so: “[I]f you look at the following linked commentaries, I am happy to issue appropriate corrections, revisions, updates, or more if it is in order.” Taleb did not respond.
1 “I went for the jugular—we went for the max. I was interested in screwing these people—I’m not interested in money, but I wanted to teach them a lesson, and the only way you can do it is by trying to take it away from them. We didn’t short the banks—there’s not much to be gained there, these were all these complex instruments, options and so forth. We’d been building our positions for a while…when they went to the wall we made $20 bln for our clients, half a billion for the Black Swan fund.” (First page, second column, 7th full paragraph of “The Thinker,” GQ UK edition, May 2009)
2 Taleb’s web site home page showed this article as one of two “most representative overall profiles.” After my [May 19] query, Taleb added a qualifier next to the link to the article: “(with typo on the ‘billions’).” [with no further clarification at that time]
Additional Endnote: The GQ article had been posted on Taleb's web site sans notes or corrections and flagged as one of two articles being “most representative overall profiles.” Other media referred to the GQ article and incorrectly attributed $20 billion in gains to Taleb ["Nassim Taleb is the Lebanon‐born derivatives trader known for...having made clients of his Black Swan fund $20 billion from shorting the markets last autumn." under "Tinkerman," The Times, April 7, 2009. The Times referred to the correction on July 3, 2009 after other media outlets noted my commentaries and reported the error.]. It was brought to my attention in May, and I contacted Taleb about GQ’s reportage of the $20 billion gain on May 19. After my initial inquiry, Taleb added “(with typo on the ‘billions’) to his web site’s link to the article, but he added no further clarification of the numbers at that time. Almost one month after several web‐based media outlets questioned GQ’s reportage, Taleb provided more information. At the end of June 2009, Taleb added a correction note to the article he originally posted as "most representative" with no clarification. Instead of making “$20 billion for our clients, half a billion” for the Black Swan funds [per the original article and Taleb’s uncorrected original web site posting], and instead of making “almost [emphasis in original] half a billion for the black swan funds,” [per a December 2008 email to Will Self that Taleb later put in the public domain on June 30, 2009], Taleb’s late June 2009 correction now says the $20 billion was notional exposure in future value of options, and the funds made between “a quarter and a half a billion.”
Hat tip to alert readers and Chicago’s option market makers. Thanks also to Nassim Taleb for confirming the inaccuracy of the quote. Will Self, the author of the GQ article, did not respond to an email sent to his agency.
Taleb’s Stranded Swan?
June 3, 2009
Before penning my previous commentary, I contacted Nassim Nicholas Taleb to check whether there were any inaccuracies in a Wall Street Journal article about the performance of his previous black swan fund, Empirica Kurtosis Ltd. The article said the fund had a 60% return in 2000 followed by "losses in 2001 and in 2002.” In 2003 and 2004 it had low single-digit gains, a period when hedge funds posted average returns of 20% and 9% respectively. The fund’s size was around $375 million when most of the assets were returned to investors.
In my query to Taleb, I also asked for confirmation that the fund experienced a voluntary wind-up…more on that later.
Taleb did not respond. Considered with his previous coy reply regarding GQ’s mythical $20 billion, I gave up hope of clarification. I enjoy debating philosophy, but debate is no substitute for size of actual gains.
I was particularly interested in Empirica Kurtosis’s reported anemic performance in 2001, because according to Taleb, the 9/11 terrorist attacks of 2001 were a “black swan” event.1
How can a black swan fund do so poorly when the black swan finally appears?
Imagine a scenario: When the black swan appears, investors panic. The fund manager wants to cash in gains when volatility soars. Nervous investors want the manager to buy more “insurance,” when it is expensive and ill-considered. But investors should not be blamed for a black swan fund’s anemic performance any more than a pilot would blame nervous passengers for a bumpy plane ride. Management takes credit (and juicy fees) for the gains, so it should take responsibility for overall performance. This scenario may not be relevant for Empirica Kurtosis, but then, what is the explanation?
What about the voluntary wind-up I mentioned earlier?
Taleb’s web site stated EMPIRICA WAS NEVER CLOSED [emphasis in original].2 That may be true if one is only referring to Empirica LLC, a risk management operation. But in my opinion, it is incomplete to assert this without mentioning the voluntary wind-up of Empirica Kurtosis Limited.
Taleb never responded to my query about the wind-up. The Bermuda-based trustee was more helpful and confirmed that Empirica Kurtosis Limited was indeed wound up in 2004/2005.
Winners’ Swan Dive
Big wins and big losses always occur after any market move. Winners are eager to claim they were smart—not lucky.
The big picture should be big enough to provide perspective. A black swan fund may have a good year followed by losses and mediocre returns. Empirica Kurtosis Limited may have become an example of a black swan fund with clipped wings.
(See also: “Taleb Kills $20 Billion Mythical Swan,” June 1, 2009)
&nb
sp; Endnote: On June 3, 2009 I sent this to Taleb to give him a chance to respond to my commentaries if he chose to do so: “[I]f you look at the following linked commentaries, I am happy to issue appropriate corrections, revisions, updates, or more if it is in order.” Taleb did not respond.
1 Excerpted Transcript May 8, 2007 – The Colbert Report (Stephen Colbert interviews Taleb)
Taleb: Take Google, September 9/11, the rise of the internet, Harry Potter…They were unexpected and no one saw them coming, and after they happened, oh yah, it was so explainable by historians, scholars and academics, but before they happened, they were so unexpected.
[Later]
Colbert: So you say…9/11 could not be predicted.
Taleb: It is very very hard to predict these events.
[Apparently Taleb never heard of the August 2001 presidential briefing: “Bin Laden Determined To Strike in U.S. based on a July 2001 intelligence report.]
Colbert: …I’m glad to hear that, because that means the 9/11 Commission was a waste of time. Because we shouldn’t have investigated why it happened, right?
Taleb: You need you need [sic] to investigate to see if it is predictable or not…
Colbert: But why? Why investigate something that can’t be predicted, because there is nothing to learn from it.
Taleb: No, after the fact, Okay, you have to look at…uh…first of all you can learn something from the event, it’s not like you can’t learn at all.
Colbert: Okay
Taleb: But 9/11, 9/11, what I’m saying is that its there is so many events like 9/11 that could have taken place, you see, so, its just to see if there’s responsibility, is there any vigilance or no vigilance. This is why we investigated 9/11.
Colbert: ..Is Iraq a Black Swan? We couldn’t have ever foreseen it would go poorly, we would never have known that was not going to go well…
Taleb: No, wars, wars, yah, listen, wars since Napoleon…we learned that wars…wars are more and more unpredictable, more and more complex, the link between action and consequence becoming fuzzier, and I think that the war in Iraq was a mistake…we should have seen that it could have led to these dire consequences. [Only since Napoleon?]
Colbert: We should have but we didn’t, therefore we couldn’t.
[Later]
Colbert: It seems like you’re essentially saying the future is unpredictable.
Taleb: No, I’m saying, yes, my idea in the book is to show two things: number one that the future is rather unpredictable, it is dominated by Black Swans and these black swans are not predictable, and the second point that is quite central, is that we humans…all right?...try to concoct stories to convince ourselves that the future is more predictable than it actually is…[Like Taleb’s Napoleon story?]
Colbert: The future is essentially not predictable.
Taleb: Yes, it’s not.
Colbert: By that logic, doesn’t it mean that in the future you will be able to predict things, because you are predicting that you cannot predict things?
2 The only mention of Empirica on Taleb’s web site was as follows: “Owned Empirica LLC a trading/hedging/protection operation (currently the business became the Black Swan Protection Protocol managed by the traders at Universa –I am an advisor). Note that EMPIRICA WAS NEVER CLOSED. Current Corporate Boards: a few hedge funds. A prophetic novel by Viken Berberian about Empiricus Kapital.” There was no mention of Empirica Kurtosis Limited (Emprica Kurtosis), a fund, or of its returns even though it seems it may have been part of this operation at one time. The fund’s returns are not mentioned in Taleb’s Wikipedia profile (as of this writing). The returns for Empirica Kurtosis Limited are mentioned in Mark Spitznagel’s Wikipedia profile, but in an incomplete way. Spitznagel was a partner with Taleb in this venture: “Empirica was reported to have made a 60% return in 2000 and lower (though unconfirmed) returns from 2001 to 2004.”
Gasparino’s Glass Jaw Was CNBC’s Draw
July 22, 2009
Why didn’t CNBC give early warning of Wall Street’s implosion? Perhaps because CNBC’s on air reporting usually isn’t hard hitting, despite what media articles may say. It’s a good thing former pugilist, Charlie Gasparino, didn’t try for the Golden Gloves.
Gasparino’s July 14, 2009 rant about Goldman Sachs was very late to the party. On the topic of Wall Street, the only “f-bomb” Gasparino failed to drop is the fraud pulled off by Wall Street firms when they failed to properly mark their books and fueled massive problems for the American economy. On July 20, Gasparino was easily fooled by Goldman’s assertion it is responsible for a public service (liquidity and a backstop) and failed to analyze the key legitimate issues that need to be addressed by reformers: Goldman’s (and Wall Street’s) undue influence over Treasury and Fed officials and Wall Street’s need to make reparations to the U.S. Treasury.
Goldman runs a hedge fund. This observation isn’t new, and Goldman is not alone among our large banks in running invisible hedge funds . Many others raised substantive issues about Goldman and Wall Street long before Gasparino, and they haven’t caved.
There are many good reporters who actually read documents, analyze them, and know how to sift good information from bad, but Gasparino isn’t one of them these days. Here’s a tiny Bear Stearns sample:
“Jimmy Cayne built Bear Stearns from the ground up* with one key ingredient: guts. We induct a Wall Street icon” by Charles Gasparino Trader Monthly Jun-Jul 2007 [Trader Monthly ended operations February 2009]. At the beginning of August 2007, Gasparino’s mantra was:” “When I had dinner with Jimmy Cayne on Sunday night.”
Compare that with this 2005 Bear Stearns CDO expose or this May 2007 BSAM related subprime CDO / IPO expose [Matt Goldstein, the articles’ author, is now a journalist for Reuters.] or with Jody Shenn’s work on Bear at Bloomberg News.
[Disclosure: I was quoted in these articles, which is why I had the examples handy. There are many other good reporters in financial media.]
Footwork Needs Work
After-the-fact reporting is not the same as being “ahead” of everyone else. Here’s Charlie in Oct 2007 with me discussing Merrill. Not only was CNBC very late to the party regarding the meltdown, Gasparino makes a typical assertion: “When we reported [Merrill’s write-downs] here three weeks ago…ahead of anyone else…” right after I point out I wrote an article about Merrill’s short-able positions, “The Predators’ Fall,” ten months earlier (and gave warnings about Wall Street’s phony products, overrated products, and excessive leverage much earlier than that).
VIDEO: Inside Merrill Lynch – CNBC – October 24, 2007
Gasparino Can’t Take a Punch
As for Gasparino’s on air etiquette, Squawk Box’s Joe Kernen has the right attitude. In this January 2008 clip, around 3:44 minutes in, Charlie protests to me: “Would you just let me finish, would you just let me finish! You sound like me, now…let me finish.”
Joe Kernen laughs: “So you know you do it, I didn’t know you knew you did it, Charlie!”
VIDEO: The Bigger Problem for Bonds – CNBC – January 25, 2008
Disclosure: Near the end of 2007, a producer for CNBC’s Squawk Box asked me if I wanted to go on regularly with Charlie, because I took him in stride. I declined.
Where Were Drama Pundits [Whitney, Taleb and Gasparino]
When It Mattered?
July 29, 2009
Hundreds of people from clergymen to lawyers have claimed decorations for bravery that they never earned. Why should finance be any different?
Meredith Whitney’s Unreported Death Threats (See also: “Reporting v. PR”)
In the early part of 2007, Meredith Whitney appeared on Cavuto on Business with Jim Rogers and opposed his viewpoint. She rated Citigroup “sector perform.” Rogers was short. By the end of October 2007, three other prominent analysts already had a sell on Citi; Whitney followed by rating it sector underperform and said Citigroup could trade in the low ‘30’s and would have to cut its dividend. The dividend cut w
as a good call. Rogers made it months earlier when he shorted the stock. It was too late to give an early warning about Citigroup’s toxic assets. Securitization had already ground to a halt, and everyone was taking losses. Citi hit $5 in January 2009, just as Rogers said it would.
According to Reuters, Whitney said she got “several death threats” as a result of her Citi call. The rumored death threats were widely reported. But who told the press about death threats? Security consultants advise the target of death threats not to discuss it, particularly not with the press. The threats were downgraded faster than Whitney downgraded Citigroup—a Fortune interview said she received “one death threat.” Whitney rated Bear Stearns perform and downgraded it to underperform on March 14, 2008 as it tumbled 53% in one day. Clues to Bear Stearns’ problems were publicly reported in May 2007 when the Everquest IPO became news, and CDOs from BSAM’s hedge funds landed on Bear Stearns’s balance sheet. Reportedly, Whitney hesitated Bear’s fateful week of March 2008 due to her perceived pressure over her Citi dividend call, but pressure or not, she was already too late.