Wednesday, January 16, 2013

Antifragile: Taleb’s Barbell Investment Idea

Continuing my little series exposing some of Nassim Nicholas Taleb’s ideas in his new book Antifragile. I would now invite examination of his interesting idea of a barbell investment strategy.

Briefly, his idea is two put your assets (investment assets I presume, he does not spell it out) into two general categories. One is, say, 90% of your investments into very safe (short-term Treasuries for example), that would be one side of the barbell, the other 10% of your investments into VERY SPECULATIVE stuff, the more volatile the better.

He does NOT believe in investing in the middle (like stocks for example, commercial real estate or bonds), as there are hidden risks in many investments.

His barbell strategy also fits his general theme of putting oneself into a position to benefit from upside volatility (where rare random events are in your favor).

Here is a barbell that I will use to illustrate — I never got any praise for artistic skills.

Let us imagine that the left side of the barbell would be the safe (90%) side. In his book he says ideally this would be cash that would just beat inflation, but that is hard to find now, a safe investment that throws off an income of, say, 5% (perhaps a median estimate of inflation now). Perhaps we could expand the allowed safe investments on the left to include gold.

So, we could take care of the safe investments by stipulating that the left side would be 50% in short-term Treasuries and 50% in gold (or 45% for each of the two of your total investments).

And the right side? The more risky and volatile the better! Here are some candidates:

— FAS and FAZ (the 3 x ETFs on the banks, also the other 3 x ETFs)

— Options, especially CHEAP ones. (His career has involved a lot of study on options)

— Derivatives of all sorts, especially leveraged!

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Taleb’s idea here is to limit the absolute maximum loss to 10% of the portfolio while allowing for BIG INCREASES when the risky stuff occasionally pays off. And typically, it will, if you have the patience (and capital) to wait it out.

Note that I do not yet practice what he preaches (I wonder how much so he does?). It is an interesting idea, with much to be said for it, but I am not prepared to make that jump.

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I mentioned gold as a safe side investment. Taleb mentions gold in his book, so far two or three times. He kind of hints at it as something safe, but never comes straight out with it. Gold is not even in the Index. But, gold has a long (5000 year) record of being a store of value, so I think gold merits its place as one half of the safe (left) side of the barbell. Now we have (click on the image for a better view):

I am very much a fan of diversification! Even if I drift towards his investment idea (very possible), I will likely keep some stocks as well as our company in Peru (even though those ARE in the middle). Taleb does not discuss geographical (political) risk for example. Diversification (he is rather strict in what really IS diversification, as so many investments are actually highly correlated) and redundancy do fit into Taleb’s great ideas of antifragility .

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I plan on further explorations into his ideas. These will perhaps include our own company there in Peru (how fragile or not it is), gold, small is better, iatrogenics, and others.

I cannot recommend his book high enough.