In 2008, u.s. stocks plummeted, with the s & p 500 down 37%, the biggest drop since the second world war. All kinds of funds have failed one after another, with numerous deaths and injuries, and even the stock god Warren Buffett has lost 9.6%. The bridge fund, which manages $50 billion, bucked the trend with a 9.4% return on investment, and Bridgewater Daily Watch even became a daily read by then US Treasury Secretary Timothy Geithner. Founder Ray Dalio went to the altar, writing books and sermons along the way.

Also in this crisis, Mark Spitznagel (Mark Spitznagel), then unknown, bucked the trend and made a 115 per cent return on investment. Global Investment (Universa Investments), which he founded, was registered in January 2008 with initial assets of just $300m, much of which was funded by his teacher, Nassim Nicholas Taleb.

The two hedge funds, which bucked the market in the stock market crash, have very different investment strategies. The former focuses on asset allocation and pursues risk parity, while the latter stubbornly bet on the "black swan" event, using option combinations to attack extreme markets. The former is based in Westport, an hour's drive from Wall Street, while the latter is 1300 miles away in Miami, Florida, deliberately away from Wall Street. In the years that followed, the two funds advanced by leaps and bounds.

The Bridge Water Fund has developed into one of the largest hedge funds in the world, with a management size of US $160 billion. Dario's "principles" is a best-selling book that is regarded as Nirvana by Chinese investors, while Global Investment has successfully bet on several market crashes. In 2015, due to the collapse of the Chinese stock market, the Black Swan strategy began to be gradually recognized by the market and investors.

2020 is a watershed, the epidemic and the collapse of oil prices two "black swans" followed, stocks, debt, gold and other assets all fell sharply. The "myth of invincibility" of the Bridge Water Fund has been exposed, and the all-weather strategy fund, which Dario has been proud of, has lost 20%. At the same time, Global Capital, which has long bet on "Black Swan", became the winner of the market's epic turmoil, making 36 times its profits in March and returning more than 41 times in the first quarter, bringing clients at least $3 billion.

The arrival of "Black Swan" connects Dario and Mark again. Unlike in 2008, Dario lost this time, and Mark was in the limelight. "I should have made money instead of losing money like I did in 2008," Dario said in a thousand words of disappointment and bitterness.

In fact, this is not the first meeting between the two bigwigs and two hedge funds. CIC, which is in charge of China's sovereign investment, negotiated with Global Investment in 2010, but chose to become an institutional client of Qiaoshui. The "all-weather" investment strategy centered on risk parity over the past decade has crushed the "black swan" in terms of momentum, and now in the epic volatility, the "black swan" has hit the "all-weather". Behind the change of the effectiveness of investment strategy is the earth-shaking of the whole financial market and even the world pattern.

This article will use three parts to introduce the investment philosophy and the great changes of the times behind Mark Spitznagel's top deal:

1. Catastrophe Insurance and the War of Asset allocation

2. Mismatch between normal distribution and fat tail effect

3. The Black Swan Age of Global Asset allocation

01 the war between catastrophe insurance and risk parity

In early April, WSJ revealed parts of Mark's letter to investors, and the 41-fold return on investment in a single quarter shocked Wall Street. Interviews poured in when senior journalists maliciously asked Mark what he thought of Dario and risk parity. Mark said bluntly, "I think this strategy is naive" after a few polite words with no intention of becoming a target.

Mark is not targeting Dario, but an euphemism for "everyone here is rubbish."

The risk parity strategy can be regarded as the most respected investment concept on Wall Street. According to China International Capital Corporation, the total size of volatility strategy products is 800 billion US dollars, of which the risk parity strategy is about 170 billion US dollars, including half of the assets managed by the Bridge Water Fund (about 80 billion US dollars). The annual return of 7.8% since the establishment of the Bridge Water Fund has become the best interpretation of its effectiveness.

The core of the so-called risk parity strategy is to allocate assets automatically when the latest risk situation changes according to the historical volatility attribute and risk correlation degree between various assets. It takes the volatility of asset prices as a means of measuring risk, and keeps the total volatility roughly unchanged by increasing assets with reduced volatility and reducing assets with rising volatility. Compared with the traditional 6:4 allocation of stocks and bonds, this allocation scheme has a better Sharp ratio.

Mark explains why he is dismissive of this popular strategy, which many investors underestimate because of the risk parity strategy that allocates bonds in the portfolio.

Another core of this strategy is the use of a large amount of leverage to enable low-risk and low-return assets (such as bonds) to get reports and risks that match stocks and so on. This kind of leverage portfolio will virtually magnify the risk, especially when the market fluctuates violently, in order to reduce the volatility of the portfolio, it can only be forced to close the position and accept losses. Zhang Yidong of Societe Generale Securities firmly believes that the rapid decline of US stocks is caused by the stampede of risk parity strategy.

High leverage will lead to the so-called "fat tail effect" (fat tail), that is, the return assumed by portfolio theory does not obey normal distribution. To put it simply, reducing the volatility of the portfolio through allocation and leverage will lead to an increase in tail risk, which is likely to lead to losses in the extreme market. Mark repeatedly stressed on different occasions that reducing volatility does not mean reducing risk.

In February, Mark published an analysis of hedge funds' investment returns over the past three decades, pointing out that hedge funds have been trying to reduce risk by building cross-asset portfolios in the past, but that has never happened. "this is actually a deep-rooted misunderstanding, blamed on modern portfolio theory (MPT). "

Asset allocation wins a smooth net worth curve, but catastrophe insurance can really make money. Its conclusion can be called unorthodox, we should know that modern portfolio theory can be called the cornerstone of contemporary western securities investment theory.

In 1952, Professor Markowitz published a paper entitled "portfolio selection" in the Journal of Finance, which applied the theory of probability and linear algebra to the study of portfolio, and won the Nobel Prize in economics. It emphasizes that investment should be diversified, and the risk of different types of financial assets is less than that of a single asset, and the risk can be reduced through asset allocation.

But in Mark's view, modern portfolio theory, which emphasizes low correlation and Sharp ratios, cannot reduce risk at all, and the most important reason for Bridgewater's success in the past is that the Fed has kept interest rates low for a long time, causing other asset prices to continue to rise, masking the risks of the market. He is also sceptical about market forecasts that Mr Dario is keen on. In his words, "there is no crystal ball that can predict the future".

Mark believes that by betting on "black swans" to reduce the adverse impact of huge losses on the long-term compound growth rate of the portfolio, it is an effective way to control risks and obtain excess returns. He creatively put forward the concept of "volatility tax" and believed that the purpose of the "Black Swan" strategy was to reduce the volatility tax on investment portfolios.

Volatility tax is an original concept invented by Mark, which can be called the curse of investment. The asset price from 100 yuan to 50 yuan only needs to fall by 50%, but the increase of 100 yuan requires a 100% increase. The mismatch between the 50% drop and the 100% increase is the fluctuation tax. If investments want to make money, they must avoid a huge pullback and reduce the impact of fluctuating taxes.

In this perspective, no loss is the core of investment, and diversification can not achieve this. Mark's approach is to "catastrophe insurance" on assets or, more simply, to buy a portfolio of put options. By using a small combination of put options to protect assets, we usually lose a small amount of option fees, but when the market fluctuates violently, the options will bring crazy returns and achieve the non-withdrawal of the whole asset price.

Bloomberg has reported that Global Investments bought about $2 each of the S & P 500 put options in April 2010. the option expires in May and will be rewarded if the index falls below 1100. If not, Global Investment will lose all its money. At the time, the index was about 1200. During the market crash on May 6th, Global Investments sold put options at the high end of the 60-dollar Academy. At that time, S & P fell to 1066 points, wiping out $862 billion of U. S. stock value in 20 minutes.

Therefore, Global Investment is different from traditional hedge funds, and its clients are often financial institutions that hold huge assets, such as pension funds and sovereign funds. The assets designated by the client need to be "insured" to provide an additional part of the funds to Global Investment, Global Investment Management and charge a corresponding commission on the additional funds.

Mark likes to use the S & P 500 as an illustration, and in a letter to shareholders earlier this year, he demonstrated that "catastrophe insurance", which holds 96.7% of the S & P 500 and 3.3% of global investments, has achieved a return of 319% over the past decade. It is better not only to hold the s & p 500 alone, but also to allocate 75% of the s & p 500 and 25% of other assets.

The collapse in March this year has made this investment strategy even more brilliant. When the black swan hit, U. S. stocks were cut one after another, and the liquidity crisis led to the indiscriminate sell-off of traditional safe-haven assets such as treasury bonds and gold. When all the assets fell together, the asset allocation became meaningless, and the Bridge Water Fund suffered heavy losses, and there were even rumors of a burst at one time.

Forbes estimates that Mark's catastrophe Insurance position is less than $100m, protects $4.3 billion worth of financial assets and generates at least $3 billion in returns for clients investing around the world. This is not the first time Mark has made huge profits from the market. Since its inception, Global Investment has repeatedly made amazing wealth in the extreme market.

In September 2008, the S & P 500 put option that Mark bought for 90 cents was finally cashed out at $60, earning nearly $5 billion; on May 6, 2010, US stocks were pulled back by a flash crash due to Greek debt problems. the huge short option contract of Global Investment is considered to be an important incentive; on Aug. 24, 2015, when China's A shares suffered a second stock crash due to exchange rate reform, the Dow tumbled nearly 4% that day, while Global Investment made a profit of $1 billion that day.

In fact, the risk parity investment strategy of the Bridge Water Fund and the catastrophe insurance investment strategy of global investment are both trying to resist market risks. Risk parity allocates less related assets such as stocks, bonds, commodities, and so on, recording a perfect Sharp ratio in the regular volatility of the market; catastrophe insurance uses a small amount of option investment to benefit from sharp market fluctuations and uses continuous small losses to avoid a huge pullback.

Generally speaking, the risk parity strategy may be more suitable for the shock city, because of its rising and falling properties, it is difficult to beat the index in the extreme bull-bear market; on the contrary, the catastrophe insurance-style black swan strategy is more suitable for the extreme market. Good at managing tail risks, "born in the end, die in mediocrity".

Both investment strategies are designed to spread risk, so why is there a very different trend of net worth in this round of market slump? It may start with Mark's teacher Taleb, the narrator of the Black Swan.

02 mismatch between normal distribution and fat tail effect

After making a fortune in the stock market in 2010, Mark bought Idyll Farms, a century-old 200-acre farm on the shores of Lake Michigan, for less than $1 million. Mark ignored the cherry orchards and maple trees and made goat cheese here. Interestingly, Mark's goat cheese won seven awards at the "Dairy Oscar" American Cheese Association meeting in 2017, making it the best handmade goat cheese in the United States.

Mark was mentally and physically relaxed on the farm, and he thought there was something in common between making handmade cheese and making a good investment. All in pursuit of natural harmony, this vegan financial mogul hates modern agriculture and machine trading, and believes in mathematics.

The fund manager who can't make cheese is not a good mathematician. Mark's global investment is made up of 12 PhDs in mathematics. The company's logo is very mathematician and has a bell-shaped distribution. They saw Jacob Bernoulli as the patron saint of the company and put an idol of the 18th-century mathematician on the front page of the official website.

Both Jacob Bernoulli and Zhengtai distribution are closely related to the "black swan" investment strategy of Global Investments. In the words of Global Investment consultant Nassim Nicholas Taleb: he and Mark built a set of investment strategies based on risk theory around Bernoulli's law of large numbers.

Its core idea can be summarized as that the expectation of the black swan event in asset volatility far exceeds the expectations of investors, and it is quite cost-effective to bet on the black swan event at a very small cost.

In fact, the premise of this strategy is that the fluctuation of asset prices does not conform to the positive too distribution, but there will be a very obvious fat tail phenomenon (fat tail).

Economist Eugene Fama actually has a very deep insight into this point of view, pointing out that if share prices had a normal distribution in the past, there would only be a big rise of five standard deviations in 7000 years. But in fact, the stock market happens every three to four years. Fama's conclusion is that if the rise and fall of the stock market is plotted as a graph, there is bound to be a "fat tail" in the graph.

It is worth mentioning that Eugene Fama was one of the founders of the "market efficiency hypothesis", and the Nobel committee awarded him the economics prize in 2013 for his research on the predictability of stock prices. This is interesting, also based on the fat tail effect of price fluctuations, Eugene Fama has come to a completely different conclusion from Taleb.

Taleb believes that black swans are far more likely than investors expect, but it is impossible to predict when black swans will appear, and an anti-fragile portfolio needs to be built in day-to-day asset allocations. to ensure a good return on the portfolio in the face of the Black Swan event.

Taleb wrote his thoughts on "randomness", "uncertainty", "rare events" (black swan event) and other issues into the "uncertainty trilogy": "randomly walking fool", "black swan", "anti-fragility". Taleb himself is rumored to have achieved financial freedom through put options during the 1987 stock market crash. Almost every American trader has a copy of his book Black Swan.

Taleb, who was born into a famous family in Lebanon, saw his country "go from heaven to hell" within half a year. His family once owned large tracts of land in northern Lebanon and eventually came to naught. This made him wonder why extreme things always happen. Perhaps the only truth of survival is that no one knows if one day everything around you will disappear in an instant.

In the summer of 1997, Taleb predicted that hedge funds such as long-term Capital Management (Long Term Capital Management), which did not pay attention to the fat tail effect, would go wrong sooner or later.

LTCM, the long-term capital management company, was the top hedge fund in the United States at the time, and its founding team had a luxurious all-star lineup, including Merriwether, the father of Wall Street arbitrage, and Morton and Scholes, who were at the highest level of financial modeling at the time. LTCM's trading strategy, which focuses on highly leveraged bond arbitrage, once made a lot of money, with an average annual return of more than 40%, shocked Wall Street.

But this strategy ignores the low probability of a "black swan" event-a debt default. In 1998, Russia suddenly announced that it would postpone the repayment of its short-term debt, which triggered turmoil in the global capital markets. LTCM had to sell the bonds of the seven major industrial countries in large quantities because of its 60 times operating leverage. But in the end, there was no way to save himself and ended up in bankruptcy. A top team, a near-perfect investment strategy, plus a quantitative trading boost, but ultra-high leverage and a black swan destroyed in an instant.

Taleb often quoted the philosopher David Hume as saying: "No matter how many white swans you have seen, you should not jump to the conclusion that all swans in the world are white." However, seeing a black swan is enough to refute the conclusion that swans are all white. "nothing is ridiculous. The probability of "black swan" is small, but it does exist.

In 1999, Taleb founded the hedge fund Empirica Capital (empirical Fund), with Mark as chief investment officer. The two began to accompany as teachers and friends for more than 20 years. Taleb taught Mark's investment philosophy, while the calm Mark helped Taleb resist the impulse of human nature. When Taleb, who boasts to look like Sean Connery, clashes with people in a bar, Mark is often the one who fights.

The average trader gets positive feedback from daily profits, while Empirica traders are in the midst of day-to-day losses. They buy those very cheap options and watch their value slowly return to zero. "We will not lose everything overnight, but we will slowly bleed to death," Taleb told traders. In the torment of losing money every day, reason such as Taleb has developed the habit of superstition, parking in the same parking space and refusing to listen to Mahler symphonies and so on.

At times like this, Mark is often comforting Taleb, telling him, "We have higher wisdom, and we are the victorious side." Finally, Empirica made a lot of money by holding a large number of put options on the US stock market during the 9 / 11 incident in 2001.

However, due to Taleb's poor health, Empirica Capital stopped operating in 2004, and Mark also switched to Morgan Stanley and became head of securities options trading in the proprietary department. Two years later, Mark founded Global Investment in the small city of Santa Monica, California, with Taleb as an adviser, not only using a "black swan" hedging strategy similar to Empirica, but also continuing Taleb's style of staying away from Wall Street, not reading newspapers, and not operating with news.

Perhaps Mark is the better investor to execute the Black Swan strategy than Taleb. According to Forbes magazine, Mark makes dozens of trades every day, and about 95 out of every 100 trades lose money. But he doesn't care. He just wants to make a lot of money like the wind sweeping away the fallen leaves when there is an extreme black swan incident in the market.

Mark was able to be patient in the blood loss, in addition to the rational judgment of the "Black Swan", but also benefited from the enlightenment of the well-known futures trader Everett Everett Klipp. At the age of 16, Mark was apprenticed to CME Group Inc, trading in commodities such as cotton and soyabeans. Clipper's first lesson was: "learn to take losses and get out in time before they escalate into disasters."

His experience growing up on the Chicago trading floor is a good training for the Black Swan strategy. "I learned to lose money at the pit stop. In my way of trading, I must be willing to look like a fool for a long time, suffer a small loss and wait for a big winner. "

Mark has publicly described his complex investment strategy, using 0.5 per cent of his clients' stock exposure each month to buy options with a two-month bearish target price of 30 per cent, sell these put options a month later, and buy new put options. Mark explained that when the Tobin Q value shows that the market is overvalued, this simple buy-and-hold strategy can even generate a 4% return a year.

Previous disclosures from Global Investments show that their portfolio uses 3.3% of the options portfolio to protect 96.7% of the S & P 500 assets. In a big bull market like 2017, volatility fell to an all-time low and buying put options was considered a waste of money. But Mark was extremely excited, like finding kids in the candy store full of cheap candy, because the option price was so low. The wild swings in February 2018 once again brought great wealth to clients of Global Investment.

According to the Financial Times, investors in Global Investments are told to lose 1% or 2% of their principal each year in a stable market environment. Investors are willing to put up with such losses because Mark has proved several times that he is the hunter who is good at catching black swans. "I spent all my time thinking about the coming disaster," Mark told them. "

In a 2018 letter to investors, Mark concluded: "after a long, smooth voyage and huge market gains, investors are more confident when the chances of serious mistakes are highest." "this is a good time for us. "

Mark is waiting for a collapse. Mark is also called a winner in 2020, but what does he see this time?

03 Black Swan Age of Global Asset allocation

In fact, Global Investment is not the only black swan fund that makes a lot of money. Many hedge funds that have adopted similar strategies have also made good gains this year, including Saba Capital Management LP, Capstone Investment Advisors and 36 South of Boaz Weinstein, a well-known US hedge fund manager.

Saba's tail risk hedge fund returned more than 175 per cent this year, including a 99 per cent jump in the first 10 trading days in March, according to Reuters. The "Black Swan" strategy is one of Saba's many strategies. Thanks to the outstanding performance of the "Black Swan" strategy fund, Saba has made a 67 per cent return on investment this year and made a huge profit of $2.7 billion against the trend.

Kaishi's investment management is about $6.7 billion, and the "tail risk" strategy has generated 280 per cent returns for clients this year. 36 South returned more than 25% in February alone, its best monthly performance since 2008. In addition, Cambria Tail Risk ETF, an ETF fund that adopts a "tail risk management" strategy, also achieved a good result of 12.04 per cent in March, with its net worth up 23.49 per cent so far this year.

It may not be a coincidence that the Black Swan fund has been so bright in the most terrifying extreme market since 1929, but a manifestation of the unprecedented fragility of global financial markets.

Mark is a liberal and also a staunch Austrian school. He used Mises's prediction of the Great Depression to explain the current problems in the economy: low interest rates distorted the signal of resource allocation, companies expanded blindly, and excess liquidity caused serious asset bubbles. Rising costs will eventually prove that investment is simply unpredictable, and credit will contract rapidly in the face of a collapse in demand, resulting in a depression.

Mark believes that the environment of low interest rates and unprecedented quantitative easing, which has lasted for nearly a decade, is an irresponsible monetary experiment that will eventually lead to incalculable disaster. The central bank has created monsters beyond their control and has been kidnapped. In a low interest rate environment, investors have to do some absurd actions in pursuit of returns, such as leveraged junk bonds and short selling volatility, which can lead the market to extremes.

The largest monetary easing in the Fed's history to combat the epidemic crisis is equally absurd, but they have no choice, and no one knows what the Fed's continued easing will bring. The Fed is transferring huge amounts of wealth from the middle class to the rich, and the widening gap between the rich and the poor caused by this forced distribution is the root of the problem.

The bailout plan will only allow institutions that have created risks and made profits to escape the risks again with taxpayers' money. Risk-creating practices such as debt buybacks will make a comeback next time, and the aid package has further strengthened the vulnerability of the market.

Mark recently stressed to the media: "everyone sees the risks posed by the global epidemic, but everyone pretends to turn a blind eye to what happens next."the epidemic only threatens the bubble to burst, and it is far from over."

Of course, Mark does not encourage anyone to short the market, he has repeatedly stressed that in an overbought market, shorting will kill himself, there is no crystal ball that can predict the market. Indeed, like Mark, private equity mogul John Hussman is strongly skeptical of the crazy loose environment since 2008, but his net worth has halved in the past decade, plummeting from $6.7 billion to $1 billion.

Facing the third decade of the 21 century, financial markets are showing unprecedented volatility, so using the black swan strategy to build an anti-fragile portfolio is likely to become a popular strategy in the market. After all, the root of the popularity of the risk parity strategy may be that the past two decades may have been the smoothest period in the world in terms of a century.

No investment philosophy is always right, but the Black Swan era of global asset allocation may indeed have come.