Turbulence is where this hedge fund manager thrives
Mark Spitznagel pushes the throttles on his new twin-engine Chris-Craft Corsair 28, slicing through Grand Traverse Bay in northern Michigan on a warm day in late July. As the speedboat reaches more than 50 miles per hour, Spitznagel's blond hair flying in the wind, he churns up a big wake.
Turbulence is where Spitznagel, the founder of hedge fund Universa Investments LP, thrives. On Aug. 4, while Spitznagel is still at his lake house, the Standard & Poor's 500 Index begins to plunge as weak economic data prompt predictions of a double- dip recession. By noon, Spitznagel, a so-called black swan investor, has spoken with his Santa Monica, California-based firm 15 times by phone to capitalize on its positions to make money while other investors lose it, Bloomberg Markets magazine reports in its November issue.
At Universa's office, between conversations with Spitznagel, two traders frantically buy and sell derivatives, including options on the S&P 500. The index's 4.8 percent dive on that day is producing a windfall for Universa, says Brandon Yarckin, a Universa associate who handles investor relations. He points to a Japanese print on the wall -- one of Spitznagel's favorites -- depicting a giant wave about to crash onto a group of hapless fishermen.
“Days like today are what we are here for,” he says.
Investors are pouring into doomsday black swan funds, spurred by the spreading European debt debacle and Standard & Poor's downgrade of U.S. creditworthiness. The funds entice investors with the possibility of a huge payoff if a crisis hits; Universa returned about 115 percent to investors in 2008, according to a person familiar with the matter.
This year, as markets retreated, Spitznagel's team collected gains of 20 to 25 percent through August for its 11 sovereign-wealth-fund and institutional clients, whose investments are run in separate partnerships and managed accounts.
“I couldn't be more bearish on the stock market right now,” Spitznagel, 40, says. “The stock market has gotten stupidly expensive again. Fortunately, with our position, I don't have to time the next sell-off.”
The downside of black swan investing can be steady pain -- year after year of losses if a market catastrophe doesn't occur. In both 2009 and 2010, Universa's clients lost about 4 percent, according to the person. The hedge-fund industry had a 9.2 percent gain in 2009 and an 8.2 percent return in 2010, according to the Bloomberg aggregate hedge-fund index.
Some managers dismiss black swan funds as a costly investment fad. Philippe Jorion, a managing director in the risk management group at Pacific Alternative Asset Management Co., a fund of hedge funds, compares this form of hedging with homeowners' insurance: The premiums paid by the homeowner usually exceed the benefit over time.
On top of the ongoing losses, black swan hedge funds typically charge a 1.5 percent management fee and take 20 percent of any profit.
“The problem we have is that these hedging strategies tend to do well only when volatility is high,” says Jorion, who's based in Irvine, California. “But over the long run, there can be stretches over many years where these strategies are expensive to run and bleed money.”
Nassim Nicholas Taleb coined the term black swan as a metaphor for an unforeseen catastrophe, such as the implosion of hedge fund Long-Term Capital Management LP in 1998 or the terrorist attacks of Sept. 11, 2001. The author and New York University professor has helped inspire a cottage industry of disaster funds.
His most well-known book, “The Black Swan: The Impact of the Highly Improbable” (Random House, 2007), has sold more than 3 million copies. His latest book dispenses wisdom via aphorisms. In “The Bed of Procrustes: Philosophical and Practical Aphorisms” (Random House, 2010), he writes, “In science, you need to understand the world; in business, you need others to misunderstand it.”
Taleb, 51, shut down Empirica LLC, his black swan hedge fund, in 2005 to focus on writing and because he feared he might have a recurrence of throat cancer. Taleb also frequently lectures before business groups, academics and policy makers.
“I'm not interested in money; I'm not interested in finance,” Taleb says. “I'm comfortable enough as it is. I don't need it. Finance should be a footnote in my bio, not a central component. Why should I waste time in finance when my influence as an intellectual is so high?”
Assets in black swan and tail-risk funds, which hedge against low-probability events and are named for the tapered lines at either end of a bell curve, are ballooning. They jumped to $38 billion in April from $500 million prior to the collapse of Lehman Brothers Holdings Inc. in 2008, according to a JPMorgan Chase & Co. report.
Pacific Investment Management Co., whose chief executive officer, Mohamed El-Erian, says the U.S. may be headed for a long period of below-average expansion, is the biggest firm yet to jump into the catastrophe-hedging business. Newport Beach, California-based Pimco, which manages about $1.3 trillion, has a tail-risk strategy with almost $30 billion of assets spread across its funds. Pine River Capital Management LP in Minnetonka, Minnesota, runs the $160 million Nisswa Tail Hedge Master Fund Ltd., and 36 South Capital Advisors LLP of London, which oversees $330 million of assets, also manages black swan funds. Jerry Haworth, who co-founded the firm, says his black swan fund returned 234 percent in 2008.
Before starting Universa in 2007, Spitznagel was a partner and the head trader at Taleb's Empirica, and together, they developed their options-trading strategy. Universa, whose clients include the Canada Pension Plan Investment Board, buys out-of-the-money call and put options tied to the S&P 500, commodities and stocks.
In a typical trade, Universa pays a fee for the right to lock in a set price on the S&P 500 for a period of time, such as one year. If the benchmark index declines below this strike price, Universa's options increase in value.
“I'm a value investor in my bones,” says Spitznagel, who's also the firm's president and chief investment officer. “I want to trade on adverse expectations.”
--Bloomberg News--
