Investing for Financial Storms with Mark Spitznagel, Founder & Chief Investment Officer, Universa Investments.
Moderated by William Cohan, Bestselling Author & Founding Partner, Puck.
MODERATOR
SPEAKER
Mark Spitznagel
Founder & Chief Investment Officer
Universa Investments
William Cohan
Bestselling Author
TIMESTAMPS
EPISODE TRANSCRIPT
William Cohan: (00:07)
It's nice to see people outside of their box, and I just want to say thank you to Anthony for bringing this to New York City and pulling this off. I think he deserves an amazing round of applause. This is incredible.
William Cohan: (00:30)
I'm here with Mark Spitznagel, who's an incredible investor. My first question, Mark, is on weeks like we've just had, where the market goes down every day, I know it's up a little bit today.
William Cohan: (00:48)
Do you get more calls on weeks like last week? Or more calls when the market's hitting its all-time highs?
Mark Spitznagel: (00:57)
Good question. Universa clients tend to be very strategic, as opposed to tactical. So I would say that in general, it doesn't really matter, and I would characterize this week as basically being noise. But it's a good question, because it really is when the market is going up that risk mitigation in the right way, cost-effective risk mitigation is so important.
Mark Spitznagel: (01:26)
Because I argue that cost effective risk mitigation, when done well, doesn't just take you out of risk, but actually allows you to take on more risk, so maybe it's better to say, take more exposure. This is really important. So the more the market rallies, the more that's really something.
Mark Spitznagel: (01:41)
That's important. But, of course, we also know that the more the market rallies, the more it can take all that back. It tends to be how boom-bust cycles work. But in general, I would say that it's noise.
William Cohan: (01:54)
It's a toss-up.
Mark Spitznagel: (01:55)
It's a toss-up.
William Cohan: (01:57)
How do people get in touch with you? And who are your clients? Who are they? Who are your investors?
Mark Spitznagel: (02:10)
It would tend to be your typical institutions, so ...
William Cohan: (02:16)
Looking for risk mitigation?
Mark Spitznagel: (02:18)
Well, exactly. I mean, institutions, think of a pension fund, the problem that they face is, what I call the great dilemma of risk, which is, if you don't take enough risk, of course, it costs you wealth over time.
Mark Spitznagel: (02:33)
If you take too much risk, it costs you wealth over time, so we're forced to kind of navigate and fine-tune, and find what is termed the Holy Grail, somewhere in the middle. The Holy Grail doesn't exist.
Mark Spitznagel: (02:45)
The modern portfolio theory of modern finance can't help with that problem. Of course, we know what modern finance tells us is that you take less risk, your return goes down. As long as that ratio is, all your risk adjusted returns are going up, that's an okay thing. This is the whole machinery of modern finance.
Mark Spitznagel: (03:07)
I would argue that this is something that we should question. What that's really telling us is that the cure is worse than disease, when it comes to risk mitigation.
Mark Spitznagel: (03:17)
I argue that we should mitigate risk, specifically to save us from the losses, and we should do better than had we experienced the losses without risk mitigation. It shouldn't cost us to do that, because it begs the question, then why do we do it?
Mark Spitznagel: (03:34)
But this is what modern portfolio theory is all about. My whole point, in my book, for instance, is it doesn't have to be that way. We just need to think about it differently.
William Cohan: (03:47)
You told me the other day, that you're as bearish as you could possibly be, but also, that it doesn't matter what you think, whether the market's going up or down. Can you explain how that could possibly be?
Mark Spitznagel: (04:04)
Yeah. I mean, Cassandras make very lousy investors. I don't think there's any question about that. They know they have to get their timing there, tactically, they have to be perfect, and they never are.
Mark Spitznagel: (04:17)
But it goes to my point about how, when risk mitigation is cost-effective, it's strategic, and we actually want the market to go up more, when we are risk mitigated. A good analogy would be when dark clouds loom, do you go hide inside? If you do, when dark clouds are always looming, you're always hiding inside.
Mark Spitznagel: (04:40)
But then, an analogy for a different type of risk mitigation, one that's more explosive, and one that's more efficient would be going outside when dark clouds loom, but having an umbrella that pops open when you need it. I guess that what this is showing is that risk mitigation, a safe haven, to be cost effective, needs to be explosive.
Mark Spitznagel: (04:59)
It needs to maximize the bang for the buck that you get out of it. What that really means is you need less of it. This is the whole problem with these risk mitigation strategies, diworsifiers, as Peter Lynch called them.
Mark Spitznagel: (05:12)
You could take hedge funds as a group, for example. You could take the strategy of certainly, risk parity, or you could take certainly fixed income. It gives you such little return in a crash, that you need so much of it in your portfolio, in order to be effective. The fact that you need so much of in your portfolio creates such a drag the rest of the time.
Mark Spitznagel: (05:35)
It just ends up making you poor, that the cure ends up having been worse than the disease, for all these strategies that I'm describing. It doesn't matter if there's a crash or no crash, which again, begs the question, what was the point of it all?
Mark Spitznagel: (05:47)
But if you need it for anything, and I'm not just saying this about tail hedging, it doesn't need parts, it doesn't need ... There's other ways that one could think about this.
Mark Spitznagel: (05:55)
If all you need is a very allocation, and it has enough crash bang for the buck, as I call it, then you actually are able to take on more systematic exposure, and you actually want the market to continue. I, for one, would like this boom to go on forever.
Mark Spitznagel: (06:12)
I'm saying that as a hedge fund manager, it really only expects to make large returns when there's a crash. But the effectiveness, the cost-effective effectiveness of what we do, exists, whether there's a crash or not, historically.
William Cohan: (06:27)
Why don't you explain how this works at Universa? I mean, you've put out some incredible numbers. 2020, correct me if I'm wrong, something around 4,000% increase, but overall in the life of your fund, more than 100%, which you say in the book here.
William Cohan: (06:49)
What exactly are you doing for investors? How does it work? How does this insurance, in effect, that you're selling investors work? How do you make money? How do they make money? Why should anybody be interested in what you're doing?
Mark Spitznagel: (07:04)
But I don't claim that they should, and I have no interest in, I have no reason to get into that level of detail. People often tell me that it feels like I'm dangling this idea in front of them, because I'm not going to talk about specific trades that I do, but I would ...
William Cohan: (07:19)
No, no, forget the specific trades.
Mark Spitznagel: (07:21)
Yeah.
William Cohan: (07:21)
The idea behind your trades, what are you offering? What is this protection that you're offering?
Mark Spitznagel: (07:28)
Well, I mean, it's the result. That is what I like to talk about, because it gives a better understanding of what it's offering to the end user. That is something that explodes in value in a crash, and loses small amounts of the rest of the time.
Mark Spitznagel: (07:40)
Obviously, that looks like a far out of the money put, but I never want to lead someone in that direction, because puts, to just to stay put, and to have somebody buy a put, you could even identify a strike, and a duration is, that that's not managed correctly. You're doing something and someone an extreme disservice.
Mark Spitznagel: (07:58)
This is something that we've been, we've been working on for 25 years, and we still learn every day, how best to do this. If you don't get the bang for the buck, and you're not able to monetize these things the way you need to, it's going to be a waste of your time, it's going to be very costly.
Mark Spitznagel: (08:13)
Like I said, it's far more important, I think, for people to understand the purpose of what we try to do in risk mitigation. I don't just mean we, I mean, we all try to do, as risk mitigators, why we're doing it. Because I think these are the sort of first principle questions that we don't ask.
Mark Spitznagel: (08:30)
It's why we find ourselves creating what I call the risk mitigation irony. We mitigate against the risk, but it ends up costing us more than that, the risk of that loss would have ever cost us in the first place. But like I said, this is modern portfolio theory.
Mark Spitznagel: (08:46)
If people just think about risk mitigation in terms of its cost effectiveness, what you need to do to be cost effective, I think they're way ahead of the game. I think that levels the playing field for most people, far more than if I were to just talk, or give a basic cartoon example of what Universa does.
William Cohan: (09:05)
You also once told me that you sell peace of mind for investors. That's a pretty great product to sell.
Mark Spitznagel: (09:17)
Peace of mind, but that, I mean, look, that too sounds like a ... At what cost? At what cost do we pay for peace of mind, right? There's this expression from one of the great German commodities traders is, "The better to sleep well to than to eat well."
Mark Spitznagel: (09:36)
I don't necessarily agree with that. I think if you're just looking for peace of mind, you're going to end up having overpaid for it. Maybe I said that, but it needs to be done cost effectively. That ultimately is the key.
Mark Spitznagel: (09:47)
The only way to do that is to do it in a way that you need to put so, so little into it. And this is the problem with gold, first and foremost. I mean, I'm an advocate of gold, clearly, because of my beliefs, I'm sorry, economic beliefs.
Mark Spitznagel: (10:00)
But the problem with gold is, for it to give you the hedge that it needs to give you, you have to have so much of it in your portfolio, that when it's not doing anything for you, it represents a massive drag. And over long periods of time, you really need to have gotten the tactical call right to make that work.
Mark Spitznagel: (10:17)
I think most people probably would agree with that, because they think of gold as sort of a tactical inflation hedge. But I just don't think that tactical risk mitigation is something that any of us will ever be able to do very well. It presumes that crystal ball that risk mitigation presupposes in the first place, that we don't, none of us have.
William Cohan: (10:38)
How about crypto? Is that a store of value? Is that something akin to gold at this point? Is Bitcoin akin to golds? Or is it riskier than that?
Mark Spitznagel: (10:51)
Crypto? I mean, I think I can I get the feeling that a lot of people who are into cryptocurrencies are, I mean, they're definitely my people. I mean, I'm considering myself a libertarian, and Ron Paul, but I think the problem is that it's the speculative aspect of it that bothers me.
Mark Spitznagel: (11:11)
I mean, we think of it as an antidote to this problem that we're living through right now, we all recognize it, but I think what ends up happening with the speculation behind it is, it's turned itself into a symptom. I mean, you've got to remember, it's very easy to put your blinders on and look at something like Bitcoin, or choose your cryptocurrency, and say, "Look at what this thing is doing."
Mark Spitznagel: (11:34)
There's something special going on here, just by price action. You can't argue with that, but then you take your blinders off, and you got to look around and say, "You can say the same thing about Rolex watches and baseball cards." These things are being pushed by the same fundamental liquidity driven speculative excess.
Mark Spitznagel: (11:58)
That's not to say that there's nothing that there isn't something special going on in crypto, I firmly do believe that, but I just think we need to recognize that there are other things driving it. It isn't just the sort of idiosyncratic story.
William Cohan: (12:14)
When we spoke in February of 2020, right before the full impact of the pandemic became clear to Americans, anyway, and I remember the high yield bond then was yielding about 5%, which I thought was ridiculous, and the market was at another one of its all time highs. And I was very concerned that the market was going to correct, and I think you were, too.
William Cohan: (12:49)
In March, it did correct, in a bad, big, bad way. Of course, then the Fed stepped in, in both March and April. And now, we're levitating again, and what you were just talking about, asset prices, across the board, the market's pretty much at an all time high again.
William Cohan: (13:06)
I looked yesterday, the high yield bond is yielding under 4%. To me, this is screaming correction. You said, when we talked a few weeks ago, that you were as nervous as ever or worried is ever about the markets. What do you think it was going on here?
William Cohan: (13:30)
I mean, it's almost October, so that's usually correction time in America, in the markets. What's your take?
Mark Spitznagel: (13:39)
Well, I agree that we should all be very concerned, but the more overvalued markets get, the more they tend to get. But overvaluation is the ultimate source of crashes. This notion of a black swan event, I mean, I can show empirically, at least historically, it doesn't have to always be the case, but they have basically all come from a period of overvaluation.
Mark Spitznagel: (14:01)
The market just gets more fragile, and is more prone to pay, it pays more attention to bad news, and it's overvalued, right? I agree with you, but I just don't think that we should all of a sudden pretend that we can time this. We should be ready for it. We should absolutely be ready for it.
Mark Spitznagel: (14:16)
The problem is, when you, if you adjust your portfolio accordingly, with the sort of linear instruments, if your disposition is wrong, what you could be exposing yourself to is getting squeezed back in as the market goes higher, and just trade short. Or do you make yourself short gamma?
Mark Spitznagel: (14:34)
This is the problem when someone says, "Should I get out of the market?" There's no way to answer that question to somebody, without knowing what they're being able to forecast what they would do in certain environments, how short gamma they would be, conditional on different market moves, if the market were to run away from them.
Mark Spitznagel: (14:53)
Similarly, when someone is too long, and the market goes down, they're susceptible to selling it in the hole. I think this is the problem the question people need to ask themselves is, "What would I do in the scenario where the market moves against me?" And we probably aren't even able to answer that question honesty.
Mark Spitznagel: (15:13)
I'm not just talking about retail investors here. I mean, there are huge sophisticated pension funds that succumb to this problem of being short gamma, as a result of some grandiose forecast that they make, and position their portfolio accordingly.
William Cohan: (15:29)
I mean, do you have any sense of what the catalyst might be for correction?
Mark Spitznagel: (15:36)
I don't even have to think about that.
William Cohan: (15:37)
No, you don't, but ...
Mark Spitznagel: (15:37)
But I don't have to think about that. So the question can always be asked. It's a credit bubble, and if that credit is being generated by the Fed, why should it ever end, as long as the Fed doesn't ever end it?
Mark Spitznagel: (15:52)
I don't think that the central banks will ever pop this bubble. I think that they cannot afford to do that. It will have to come from something else. I don't think that that's a controversial statement.
William Cohan: (16:03)
No.
Mark Spitznagel: (16:04)
But the problem is, there's a limit to how much debt any entity can take on. That's why it ends up its own sort of weight.
William Cohan: (16:16)
Well, and there's, I think, at least in my judgment, a clear mispricing of risk. I mean, back in my younger days, high yield investors demanded 10, 11, 12%-plus warrants, and if Mike Milken didn't put them in his pocket, then they might actually get them. Now you've got under 4% yield, no one talks about warrants.
Mark Spitznagel: (16:45)
Yeah, yeah.
William Cohan: (16:46)
I mean, how do you reconcile the investor capitulation that's gone on, and their willingness to take incredible risk, and not get compensated for it? I mean, maybe it'll work out, maybe it won't.
William Cohan: (17:00)
On a relative basis, it's better than owning Treasuries, or whatever, that yeld under 1%. I get that whole argument, but I just don't understand why, once upon a time, they demanded 800 basis points more yield, plus warrants, and now?
Mark Spitznagel: (17:18)
Yeah.
William Cohan: (17:19)
No big deal.
Mark Spitznagel: (17:20)
Or you can just lever it up. I mean, leverage is so the panacea for a strategy that doesn't make enough money for you. I mean, it is also the excuse that risk parity, for example, uses.
Mark Spitznagel: (17:33)
Risk parity, for instance, I'm not just picking on risk parity, diworsifying strategies cost you well, but the presumption, then, is that you will just lever them up, and it won't cost you well. But of course, that's preposterous to think that it should blow your mind that you need to use leverage, financial engineering leverage, in order for a risk mitigation strategy to be effective.
Mark Spitznagel: (17:52)
But I think that is sort of a presumption, that we just do more of it, do more of it. There's a Margaret Thatcher quote that says, "The problem with socialism is that eventually you run out of other people's money."
Mark Spitznagel: (18:06)
But I think that when it comes to these credit booms, credit bubbles, the problem with credit bubbles is, eventually, you're no longer able to borrow other people's money. There's a limit to that. And I think we need to remember that. This is not just an infinite source.
Mark Spitznagel: (18:22)
This is not necessarily helicopter money, it's a debt. And fundamental to all of this is thinking, is equating debt with wealth, fundamental to the belief in this going on forever.
William Cohan: (18:36)
You have to pay debt back, last time I ...
Mark Spitznagel: (18:38)
It's a liability.
William Cohan: (18:39)
Yeah.
Mark Spitznagel: (18:39)
It's not an asset.
William Cohan: (18:40)
Not an asset. Okay. So you wrote this book, Safe Haven. Why'd you do this?
Mark Spitznagel: (18:48)
You know ...
William Cohan: (18:49)
Write a book this hard?
Mark Spitznagel: (18:50)
I almost didn't. It was very hard to get done, and it was introspection for me.
Mark Spitznagel: (18:55)
I mean, the general idea is why I approach risk mitigation the way I do. I think it's a framework, right, on how I think people should think about it.
Mark Spitznagel: (19:07)
As I said before, I think there's so much superficial narrative in what risk mitigation or safe haven investing is, so much superficial narrative, people don't ask what they're trying to accomplish in doing it.
Mark Spitznagel: (19:20)
If they did that, I think we wouldn't have these diwosrfiying strategies out there, nearly as popular as we do, because there wouldn't be a reason to do that. The logic would dictate that people would have to stop doing that.
William Cohan: (19:35)
Yeah, but we've talked about this before. I mean, retail investors, regular investors, non-institutional investors, can't really get access to your risk mitigation strategies. Being in cash, as you said, is not a great strategy.
William Cohan: (19:55)
I have found, having lived through now, three or four crashes, that if you just sort of stick with it, the market does seem to rebound, and everything sort of works out despite the pain that you're experiencing during the market disruption. What's the common man to do in this situation?
Mark Spitznagel: (20:14)
I mean, the common man is, they're kind of screwed there. They're trapped in this dilemma that I've described. This is the trap that, that has been set by central banks for our whole life.
William Cohan: (20:30)
Pretty close.
Mark Spitznagel: (20:30)
Let's say it started in the '80s, big time. Listen, everything can't be about cookbook on what your next trade should be. First of all, we got to get our first principles right.
Mark Spitznagel: (20:46)
We got to understand we're doing what we're doing. We've got to understand what to expect out of our safe haven, out of our risk mitigation strategy. Are we making a forecast? Is it a punt on its own?
Mark Spitznagel: (21:00)
Or do we think we're actually using it strategically to mitigate our risks? And if so, what should we expect of it? Is this something that we should always have on? Or do we think that we know something special about the world right now, that we're going to get this right?
Mark Spitznagel: (21:13)
I think, most people think of it, it looks like diversification is the way to go for most people. So I think most people think about safe havens and risk mitigation as just a cost that you bear.
Mark Spitznagel: (21:28)
But if you look historically at it, what you find is that that cost, you can go through all the cycles that you can find. That cost is something that you would never have made up. So then, why did you do it?
Mark Spitznagel: (21:43)
This is particularly relevant today, with interest rates where they are. Because, of course, it's fixed income that is the ultimate diversification.
William Cohan: (21:52)
It's personally relevant, particularly with interest rates where they are, and where the markets are where they are, and where other assets are where they are. I mean, it just is screaming out for correction, if you ask me. Because I've been like a broken clock right twice a day for the last five years.
Mark Spitznagel: (22:07)
But I don't disagree with what you're saying. But I still think we all need to take this sort of benevolent universe premise. What that means is, it doesn't mean that everything will turn out okay.
Mark Spitznagel: (22:17)
It means that we can adapt, and we should be working to make those changes, in order to make our way through. And that doesn't necessarily just mean we have to hide in the basement, right?
William Cohan: (22:28)
In the three or four minutes we have left here, so if we can't, by and large, get access to your risk mitigation strategies, we can get access to your goat cheese.
William Cohan: (22:43)
You have an incredible farm in Michigan, and you make incredible goat cheese, but you have a philosophy of farming that I think is pretty fascinating too. Could you share that with us?
Mark Spitznagel: (22:58)
Well, I mean, we do regenerative farming at Idyll Farms, and that's based on a very managed way, moving these ruminant goats around pasture, on this basically mimicking nature the way ruminants used to roam around the landscape.
Mark Spitznagel: (23:16)
When you do that, you get this sort of interesting symbiotic relationship between the ruminants and the pasture and the soil. What ends up happening is, the productivity of the soil and the health of the soil explodes. So this is something that is a movement that's going on right now.
Mark Spitznagel: (23:35)
But the connection that I make is, when you do this, the whole is, is pretty much greater than the sum of the parts. And I think that modern agriculture, really, that's the one thing they really miss.
Mark Spitznagel: (23:47)
Because what has modern, industrial farming done? It's taken the ruminants, put them inside, and it's planted monoculture, chemical monoculture crops on that land, and then moves it to feed them inside.
Mark Spitznagel: (23:59)
Of course, when you do that as an ecological disaster, and it's very unhealthy, and our top soil is being depleted, but that's just looking at the parts. It's looking at it in a reductionist way, which is a perfect analogy to what modern finance has done.
Mark Spitznagel: (24:13)
You break down the portfolio in a very reductionist way by optimizing some meaningless mean variance, sharp ratio in your portfolio, that just ends up making everybody poor, without looking at the whole, when you're looking at what different types of, as I said before, explosive types of payouts can do for the whole. Yeah, it seems that that has been very important to me for a long time.
William Cohan: (24:42)
Why didn't you decide to do this, as a sidelight to your investing?
Mark Spitznagel: (24:47)
Well, it was a wonderful antidote to trading and investing, but we know, of course, goats are these wonderful herding animals. And it sort of occurred to me too late, that as long as I'm out there with them, that all I've really done is moved from one herding beast, in investing in the markets, to another herding beast. There are great similarities, but it's a ...
William Cohan: (25:12)
Goats can be nicer, though, than people.
Mark Spitznagel: (25:14)
Oh, they tend to be. They tend to be.
William Cohan: (25:15)
Yeah.
Mark Spitznagel: (25:16)
But everybody needs something sort of tangible, I think, in their lives like that.
William Cohan: (25:21)
And is it a viable business for you?
Mark Spitznagel: (25:24)
It is. The other great byproduct of this sort of symbiotic relationship between ruminant and pasture and soil, is that it makes particularly good milk for cheese.
Mark Spitznagel: (25:37)
I mean, it's interesting, even in the Loire Valley, they stopped using this pasture-based model, and our cheese is far better than goat cheese from Loire Valley. There's no bias in that.
William Cohan: (25:50)
No, and I was going to say, you say so yourself. But your other location is Miami. Why there?
Mark Spitznagel: (25:58)
Well, we moved the firm from California in 2014. Listen, we all know what's going on, from Wall Street to South Florida. I think it's a very positive thing. It keeps both ends of that transaction more disciplined. People vote with their feet. It's a very business friendly environment, better time zones and things like that, too.
William Cohan: (26:23)
Well, thank you very much. Mark is an incredible investor and a great maker of goat cheese. So if you can ever get him to let you into his risk mitigation strategy, you will be better off for it. I haven't convinced him yet.
Mark Spitznagel: (26:38)
Thank you.
William Cohan: (26:39)
Thank you.