The Pomp Podcast - #1219 Scott Patterson | CHAOS KINGS: The Men Who Profit Off Disaster

Episode Date: July 6, 2023

Scott Patterson is the author of a brand new book, 'Chaos Kings: How Wall Street Traders Make Billions in the New Age of Crisis.' In this book, he breaks down two of the greatest traders in history, Nassim Taleb and Mark Spitznagel.  At Universa hedge fund, which both of them have set up and run, they are returning over 100% annually based on audited returns. They have been doing that for over a decade, one of the great runs, but the strategy they employ is even more fascinating. ======================= Pomp writes a daily letter to over 250,000+ investors about business, technology, and finance. He breaks down complex topics into easy-to-understand language while sharing opinions on various aspects of each industry. You can subscribe at https://pomp.substack.com/

What's up everyone? This is Anthony Pompliano. Many of you know me as Pomp. You're listening to the Pomp Podcast, which is my effort to find the most interesting people in the world and sit with them for hours while I ask questions in an effort to learn. So it would mean the world to me if you would subscribe to the show on your favorite audio platform, watch episodes on YouTube, and tell your friends and family about the podcast. My goal is to help millions learn from the world's most interesting people. So let's get into today's episode. Scott Patterson is the author of a brand new book, Chaos Kings, How Wall Street Traders Make Billions in the New Age of Crisis. In this book, he breaks down two of the best traders in

history, Nassim Taleb and Mark Spitznagel. Now, when I say they're some of the best traders in history, you may be scratching your head wondering what I mean. But at Universa, which both of them have helped set up and run, they are returning over 100% annually based on audited returns. They've been doing that for over a decade. It's one of the great runs. But what's more interesting is the strategy that they employ is not going long equities. Instead, they buy out of the money options and wait for big market crashes. This book is fantastic.

And this conversation with Scott is even better. Here's my conversation with Scott Patterson. This episode is brought to you by Accenture. When your advertising operations fall out of sync, everything else follows. Spotify and Accenture are working together to reinvent the rhythm of ad sales, using automation, analytics, and smarter workflows to simplify campaign delivery and access better data across the business. The result? Less time spent on operations, more time connecting brands with the moments and fandoms that matter most. Learn more at Accenture.com slash Spotify. Anthony Pompliano runs Pomp Investments.

All views of him and the guests on his podcast are solely their opinions and do not reflect the opinions of Pomp Investments. You should not treat any opinion expressed by Pomp or his guests as a specific inducement to make a particular investment or follow a particular strategy, but only as an expression of his personal opinion. This podcast is for informational purposes only. All right, guys. Bang, bang. I've got Scott Patterson here. Scott is the author of Chaos King's How Wall Street Traders Make Billions in the New Age of Crisis. It's a fantastic book, specifically covering Nassim Taleb and Mark Spitznagel. Scott, I thought a great place for us to start our conversation would be around this idea of a crisis hunter. That is a phrase that is

used a couple of times in the book and seems to be a great way to label what these guys are doing. Is that a new concept or have people always been kind of hunting crisis? It's just now with the way that the finance industry is set up, you can actually make money off of it. yeah it's interesting crisis hunter was what they uh nassim and mark called themselves when they launched their first hedge fund empirica and uh it was also one of the original titles of the book uh crisis hunters um talking with the publisher we changed to chaos kings it's a little catchier but they so they invented this concept back in the late 90s uh it evolved in their first hedge fund, Empirica. As far as I know, no one had ever created a strategy like

this that delivers these explosive returns when the market crashes. It was pretty successful back then. They shut it down mainly because Nassim couldn't handle the stress of the trading because it's a very stressful strategy because you actually lose a lot consistently. You don't You don't lose a lot of money, but you're losing a lot over time. The idea is, yeah, you might lose like a year or two, and then when the market crashes, you make way more than you lost. That's how it's supposed to work. Relaunched it.

Mark relaunched it in 2007 with Universa, and pretty good timing because 2008 saw the global financial crisis. And an interesting story I tell in the book is how when they launched Universa, which people look at now as being this very successful hedge fund managing billions of dollars, no one wanted to invest. It was such a weird, unique strategy that people just didn't get it. They traveled the country talking to portfolio managers, pension funds, family offices. and you know everybody looked at this and said you know wait a second i'm going to be losing money month after month on this thing like that's terrible you know uh traditional wall street strategies like very smooth consistent returns problem is strategies like that often have what

nassim calls hidden risk and they can suffer a lot during these crises so they have a very lumpy return. Year after year, they're losing several percent. Then all of a sudden, they make 1,000% or 2,000%. It's designed to be like time to crashes, protects portfolios. It also gives investors a big chunk of cash when everything else is down so they can take that and plow it back into the market so you start the book uh talking about ackman uh bill ackman obviously during the pandemic um he had put on basically an insurance protection uh using a somewhat similar strategy uh a couple billion dollars there uh that was able to offset losses and kind of a long portfolio uh talk a little bit about this idea that like in this hyper-connected

world people are uh predicting that there's gonna be more and more volatility and ultimately what this is doing is it's profiting off of that volatility and so uh yes nassim and mark seem to have kind of pioneered this as a standalone fund with a specific strategy but is it really that different than maybe some other hedge fund managers may be doing when they're hedging or when they're trying to uh specifically protect the portfolio that is long uh it depends on how the strategy is implemented so you know what ackman did in early 2020 was a uh a strategic trade based on his assessment of what was going on in the world with the pandemic with markets and he saw early on that the risk that he understood covid uh posed to the world

wasn't being priced into assets yet in say you know february early march so he was able to load up on these positions uh pretty cheaply he i think he only put in like 26 million dollars and that turned into 2.5 or 2.6 billion when when the market crashed so that's a strategic uh trade made on timing like just similar to what a lot of the uh you know the big short guys did for the housing market in the mid 2000s that is not what universa does their strategy is basically you always have that big short on no matter what's going on you don't make any predictions you don't try to time things it's just there because according to you know nassim's black swan uh view of the world is that nobody can predict these things they come out of the blue

uh they happen so fast that it's extremely difficult to to trade on them like you know ackman did it uh he i i see what you know he did in early 2020 was a traitor you know at the top of his game i mean he was really moving he and one of the crazy things that he did was you know he got those billions and he put a lot of it back in the stock market in march of 2020 which is you know who who does that but that trade earned him another billion um this is something that uh you know it's it's just very hard to do on a consistent basis year after year so the universe strategy is you don't time things you just put it on it's a you know what they recommend is you put about three percent of your portfolio into that tail hedge and the rest that frees up your uh rest of

your cash to put into stocks now this obviously become a very very popular strategy if you just look at the aum right i think the latest numbers that you include at the end of the book is universa has about 20 billion dollars of assets under management they have 21 employees right so kind of a billion dollars of AUM for every one employee. And you mentioned that when they launched, they only had $300 million or so of assets. And so as they have got more and more adoption, they've now become one of the top 25 largest hedge funds in the world. When you see that, is that just people kind of buying into the idea of the kind of tail hedge? Is that them doing a better job of marketing? Like what's driving so much AUM going into that strategy now? And is it

something where, you know, they went from $300 million to $20 billion on their way to $100 billion? Or how do you see kind of that future life of how big the fund could actually get? Yeah, their AUM has moved up and down a lot over the years. So it jumped up pretty quickly after the global financial crisis. And then it's, you know, one of the challenges they've encountered is keeping investors in the strategy, because after a few years, a lot of them look at it and say, hey, you know, I'm losing this money, all these, you know, past few years. I don't think the market's going to crash. Everything looks fine. And they pull out. So I tell some humorous and sad story really about CalPERS and how they were making a big investment in Universa

And starting around 2016, 2017, they were putting billions into Universa. And by late 2019, they had about, I think, a position of about $5 billion. And then a new manager took over, looked at the tail hedge and said, you know, this is a waste of money. We're just losing cash. It's never going to get big enough to matter for us because we're hundreds of billions big. So in early 2020, a couple of months before COVID really hit, they eliminated their entire position at Universa. So that's one of the hard things about this strategy is keeping people in it. So CalPERS gave up a lot by pulling out.

Why is it so big? think that you know the strategy definitely is catching on uh and more and more funds are uh getting into it i've been getting feedback from fund managers uh tail hedge fund managers who've read the book and say like oh it's great you're writing about this because it's really important um and it's effective i think people are starting to figure out it's effective and decide i write about and as mark and nassim have have talked about their strategy doesn't fit within the standard uh portfolio theory uh propagated on wall street and in finance schools that try to uh that favor strategies with low volatility um that are smooth risk-adjusted returns

you manage your risk in a way to maximize your returns. They do pretty much the opposite of what modern portfolio theory recommends. They have extremely volatile returns, losses year after year, and then big jumps. And that just doesn't fit within the models. I think that people, you know, Wall Street is starting to figure out like,

okay, doesn't fit the model, but it works, right? So yeah, there's a lot more funds out there. universe has got 20 billion we'll see if it grows maybe you know people really freaked out after 2020 the pandemic and i think it woke up a lot of people to the fact that you know there is increasing risk out there and you know as globalization expands as connectivity expands that's you know one of the driving forces of covid was you know airplanes uh people getting on planes, you know, from the blonde fashion show and, you know, flying back to America or other parts of Europe, carrying the virus with them. That a lot of epidemiologists say this,

this is a new world we're living in where these viruses are going to spread more rapidly and, you know, create the kind of chaos that we saw that year. So I think that that's, that's one of the big things that's driving the money flows into these tail hedge funds. What's fascinating to me about both Nassim and Mark is that they both kind of figured out this strategy separately in their past life before they started the hedge fund, right? And you tell both stories, obviously, with Nassim kind of doing it in the finance world and trying to understand it. But also you talk about this principle of like, maybe most of finance is based on the idea that everything is normal, and then the outlier is the volatile situation. But maybe actually,

we should flip that on its head and the volatile situations are the normal times and it's the periods of kind of no volatility that is the outlier and the reason being you know if you take away the top 10 trading days a year or something it's like pretty much flat uh and you know year in year out and so it really is all about the big moves either up or down um yeah and so is it something where uh we've almost educated an entire generation of people in finance in a perspective that fundamentally Nassim and Mark just reject because of the work that they had done and kind of the experience they had going into this? Yes. I think it's one of the key insights that they both had is that it's not focusing on the day-to-day returns. Those are

going to come. If you're in the market, you don't really need to work that hard to get those returns, what you really need to work hard on is the big crashes. And Mark likes to talk about this scenario that I think is pretty illuminating, where if you say, if you have $100 in a trade, and it goes down 50%, in order to get back to where you were, you need to make 100% return, which is pretty daunting math right so what you need to do is to protect yourself against that 50 decline and if you can do that you're going to live to trade another day and the you know the incremental returns will just come if you are in the market you know you don't need to have a real fancy trading strategy um and yeah i i you know tell this story about mark when he was a

early cub trader at the chicago board of trade in the 80s and he learned this lesson with this veteran commodity trader everett clipp who taught him something that's very contrary to what what most investors are told is that you need to love to lose and uh and this trader just beat it into him uh over and over again telling him you know this is against human nature of course but you need to get this into your strategy and what that meant is a you know trader on the floor of the cbot is if your position starts going down get out of it just get out of it right away learn you know live to trade the next day and you'll survive and you know he that that is kind of it's very similar to what nassim was doing at the same time

by buying these derivative contracts that usually lose money they're big bets on extreme moves usually doesn't happen so you lose money on that trade but when it does when you do get an extremely volatile event you make you know way more than you lost uh huge returns you know as like i also tell the story of nassim's trading on black monday when positions he bought for you know a couple pennies were trading for you know four or five bucks and that's a the magnitude of that return does not fit within any parameter of a you know a model it was so far outside the models that it was something like a trade that like that could only happen in you know once every five universes according to the uh the math so he learned early on both of them learned lessons

It was kind of from different perspectives, but when they met in late 99 at New York University, they had this mind meld where they just kind of saw that they were doing the exact same thing, and it worked. They really clicked. So they're two very different people as well, right? you at one point talked about how like mark went a couple of times i think to kind of the intellectual debates uh that nassim would hold he'd kind of like hold court in these like cafes or libraries or whatever and mark basically was like i'd rather like jump off the building right like this is horrible this is not for me uh i think you described him as like more serious uh whereas nassim was very much like kind of an academic uh in nature um is it a thing where

opposites attract because you also talk about this idea like they just enjoyed walking around New York city or other places and kind of talking and, and, you know, arguing and debating and all this type of stuff, or is there something else driving the relationship as to why they had so much respect for each other and why they had been able to work together and, and really kind of pioneer the strategy? Yeah, they definitely had similar worldviews. Like they were both into libertarianism. Um, they read some of the same philosophers like Popper. Uh, so there definitely was a chemistry there that worked and at the same time like you say they're totally different uh people the seam is you know he calls himself a funer you know which basically means like

strolling around town aimlessly and jump you know popping into bookstores and museums and i always envisioned you know him wearing these loafers and a silk scarf uh you would never as i say you would never hear mark spitznagel call himself a funer uh he is the opposite of that he's the anti-fineur huh he's the anti-fineur he's anti-fineur definitely uh he also likes you know daredevil uh hobbies like soaring on these engineless planes um skateboarding you've never seen a seam to lab on a skateboard i mean i would i would love to see that image so yeah they've got they've got very you know different uh interest in life nassim is uh as he will tell you and i has told me dozens of times uh he does not see himself as

a wall street guy as a trader as a finance guy uh he wants to be known as a as a thinker as a philosopher as a scientist um which i think he's achieved with his his books and his research people still associate him a bit with wall street especially wall street people associate him with that but i think more you know pop like his more popular images is a you know somebody who writes these fascinating books of philosophy and uh whereas mark is very happy to call himself a trader and that's all he wants to be known as he he has written some some fascinating books But they're very trade-oriented books. So, you know, I think it's why Nassim couldn't stick with it.

He just didn't have the love of the game that Mark does. And Mark, as I say in the book, when they shut down their first hedge fund, Empirica, he was furious. He was like, this is a great strategy. Why are you doing this? Don't you realize what we can do with this? and Nassim was just like I've had it, I can't do it anymore I think he was concerned about the impact

on his health that he was having he really stressed out whereas Mark he believed in the strategy he understood that you had to go through these periods of losing but it was going to pay off

he thought so he relaunched it shut down Empiric in 2004 started up Universa in 2007 And, you know, it's, it's done, it's had a very successful run. So he was right. So when you think about Nassim and kind of wanting to be more of the thinker, the philosopher, the scientist, you know, kind of the non-trader, is it almost, there's a guy, Rob Henderson, he talks about like luxury beliefs, right? And the ability to want to be that because you already made the money, right? It is like if you were just starting out, maybe actually you would be much more focused on Wall Street because it was about the pursuit of financial freedom.

And then once you get it, now all of a sudden it's like, hey, I don't care about that anymore. Now I want to be more in this other realm. Do you get the sense in your conversations with Nassim like that's part of this is that they actually had so much success early on? And then that provided the opportunity to not worry about Wall Street finance, trading and kind of personal finances. connecting brands with the moments and fandoms that matter most. Learn more at Accenture.com slash Spotify. Yeah, absolutely. I mean, he's has said that the money that he made on Black Monday was more than he's ever made in anything else. Nobody really knows how much he made. So he, you know, he says that gave him what he calls fuck you money.

And he could just go do what he want. I think he, he, you know, he's always been a reader. uh you know i talked about when he was a kid growing up in in lebanon you know he was reading all these books he there was a war going on in beirut and he was confined to the cellar and he was just reading and reading and reading um so it's it's not like he made money and said okay i want to you know become an intellectual now i think he always was uh he just um gravitated to wall street and you know it was the 80s it was a you know popular thing to do um and he he was good at it he was also pretty good at math um so you know i think the thing is and i was recently talking to him about this because as you know this seems a very divisive figure um on wall

street he's he can be very abrasive and a lot of people just hate his guts uh you know for one reason or another, either he's attacked them or, you know, on Twitter, you know, or they just think he's an asshole. I think part of it is, especially among the top tier hedge fund managers, is jealousy. You know, I know a lot of hedge fund managers. I covered the industry for years and they all almost to a one see themselves as soaring intellectuals um with uh you know they've they've read a lot uh they want to write a book many of them many some have written books haven't done that well and uh he he's kind of done what they all you know secretly want to do is become you know this popular thinker not known for the money that they've made but is being a you know

intellectual genius um and i i just think that there's there's a lot of jealousy going on there with him so you don't know this but uh during his uh transition from bitcoin supporter to bitcoin critic he uh he came at me viciously and uh i said to myself i was like yeah i i uh i said look man i got no problem with him i still uh think of him in uh incredibly high regard but uh i do think that you know part of the public like attacking of other people definitely you know puts bad taste in some people's mouth. Um, but I always do wonder, is that a requirement, right? For if you're so contrarian, if you have such a high disagreeableness, like we know that you have to be contrarian and right, uh, in order to kind of make outsized returns, does that just kind of come

with the territory? And if you think of, you know, sports as an example, uh, Michael Jordan or Kobe Bryant, or, you know, name your favorite sports person, they got some, you know, skeletons in the closet of personality that, uh, people just kind of chalk up and like, well, it's the best, you know basketball player of all time like what'd you expect he was just gonna be like this nice guy like no he's a killer right and it seems like talib maybe has uh a little bit of that as well uh and maybe that leads to some of the the abrasiveness totally and he's always been like that um just looking back at comments that he was making in the 90s uh about financial models and how stupid many of them are um and i think it it took somebody like him to uh to just say so

forcefully that wall street's got a problem it's using all of these models that hide risk and cut out the tails you know like value at risk he's been you know complaining about value at risk for decades, since the 90s, I found some old writing from him that, you know, was about how flawed that was as a risk model. And yet every bank, every hedge fund uses it. And, you know, it works 95% of the time. But what, you know, why would you use a model that cuts out the most volatile days 5% of the time of the year and say, okay, we're fine most of the time. These outliers are going to come along and we'll deal with them. So everybody's looking at the middle of the bell curve and Nassim is saying, no, that is not what you need to think about. You need to think about

those tails because those are going to kill you if you don't protect against those. And that's really um i think more than anything the innovation that he brought it many people criticized him and you can look at you know it one of the chief criticisms he's had to endure is people saying no we all knew about tails and you can find going back decades you know research showing that there's these volatile events there's these fat tails um and you know people were aware of them but they weren't incorporating them into their trading models because it screwed everything up you know i saw some uh email exchanges that he he shared with me with a very senior financial theorist a nobel prize winner actually and this nobel prize winner was telling nassim

yeah we know about the fat tails but the problem is when we put them into our models it makes things a lot harder and it's difficult to trade on them and and it seems like well you know okay you're you're ignoring reality and that's going to be a problem for you and it's kind of funny like after the global financial crisis value at risk was just completely discredited um i know we at the wall street journal we wrote about it and how this is one of the problems that the banks had is is that they didn't see the risk in the housing market because they were just looking at these average returns over years

and it wasn't even in the models. And even a lot of the derivatives that were used were using these bell curve models with no fat tails. And yet, if you look at any financial disclosure from a major bank right now, they're using value at risk, the same thing. And that's how they're managing their risk. Now, I think that a lot more are aware of being, you know, concerned about the tails

and probably are implementing hedge strategies. So hopefully, you know, that will protect them the next time there's a crash. But, you know, in early 2020, if the Fed hadn't come in with liquidity injections, like these massive liquidity injections and buying bonds and even junk bonds, um, the, you know, we would have seen the same cascading failures again, as we saw in 2008. So it's the Fed that's managing the tail risk right now. It's fascinating to think that, um, you know, Mark Spitznagel now with Universa, which Nassim, I think is still an advisor too, but, but Universa has become probably based on everything I've seen

the best performing hedge fund over the last 10 or 15 years. Um, I think in the book, you, uh, when you kind of draw the line on the returns they've averaged over a hundred percent annual returns for more than a decade right and and we've heard of yeah those are audited returns yeah so like you know we've heard of obviously renaissance and kind of 60 plus percent um and you know these kind of almost video game numbers but universa specifically uh having a hundred percent annual returns over a decade is pretty impressive um but it feels like uh where nassim is very public and he's constantly going on television he's constantly you know kind of out there as that thinker as that philosopher uh mark is much more reserved he kind of is hanging

out on his farm and uh yeah he wrote the books but i don't see him uh you know kind of volunteering to go and do interviews very often and things like that and so is that just his personality or how did you read into that yeah i think he's definitely not nearly as uh interested in appearing in public as museum is uh i think it also you know kind of enhances the mystique a bit you don't see jim simons of renaissance uh coming on tv um and in terms of returns i'd you know the medallion fund at renaissance is probably unmatched and be for one thing it's um it's It's big. It's really big. I don't know how much how big it is now, but it's, you know, what last time I was looking at that phone, I think it was 50 billion. And to get the 80 percent returns on something like that year after year is is mind blowing.

I was actually the first reporter to get inside the Renaissance office more than a decade ago when when Simons was stepping down and I knew people. so i've written a lot about them but university what was that like you can't say that they just move on what was that like when you go in the renaissance office yeah it was it was cool because they brought us into their server room which had all you know these computer uh big computers um and i thought that was fascinating because i was you know looking at these computers and thinking like what is going on inside those things um everybody wants to know they've always been you know uh a uh source of speculation and in mystery on wall street because they they seem to have cracked the code uh and they've got all these phds and you know so we walked around the

office uh it was funny it was like they're off parts of the building that had a bunch of chinese programmers and then you go down a floor and they're like here's where the russians are um so yeah it was it was very interesting when you think of uh spitznagel today you mentioned multiple times throughout the book that he's like on zoom with his traders from his farm uh what is that about like is this just uh because he's only got 21 employees and the strategy is kind of so simple and just it's about discipline it's not necessarily about day-to-day decision making, he's able to spend time doing other things or is there something else that we should take away from that? I think that it can be, and this is just me speculating because I don't

really know what they do day to day aside from they're buying these far out of the money put options. But I think there is a bit of a machine-like quality to the strategy and he doesn't need to be in the room every day when things are happening, he can see what they're doing, what the portfolio is doing. And so it's easy enough for him to get on Zoom. I think probably he has done a lot more of that since the pandemic, like everybody. But if something crazy happens,

he can jump on a plane and be in Miami in four or five hours. Yeah. And then when you look out at kind of the strategy itself, even you seem to be a little bit like, okay, I get the general strategy, but how do they actually do it is probably one of the number one questions you get. uh yeah what level of confidence could you say that you could go and explain to someone like the intricacies and the nuances is it something where they really are kind of close to their chest even though they'll describe kind of the high level but they won't explain the details or is it that the details are so complex that it's just really hard for people to wrap their heads around again i can only speculate um but you know i think that uh a big part of their strategy which you can't replicate you know on your you know interactive brokers trading

account is having relationships on well-established relationships on wall street that can allow you to put on these big positions in uh these derivatives these options that nobody else wants you know i I think they also have the stomach and the market knowledge to know that these positions, you know, which look like, you know, practically idiotic trades are going to pay off. And you just got to keep doing it because their trade is a bet on a 20% decline in the S&P 500 in a month, which is pretty nuts. It's like, you know, I think it's it's only happened a couple of times when they launched University. The only time that had happened was in 1987 when the the Dow went down 22.7 percent a single day.

So that was one of the reasons they had a lot of trouble getting investors was, you know, they look at it and say, well, this never happens. So, you know, why would I put money into that? But I think one of the secrets to the strategy is it doesn't you don't actually need a 20 percent decline for those those options to surge in value. You just need there to be a lot of fear in the market that that could happen. And that creates a sort of feeding frenzy on those positions. everybody suddenly wants them because it helps balance out their risk and their portfolios and universe is there to provide that when everybody wants it they're the ones who have those positions um they talk about like you know they're the only ones with umbrella an umbrella

selling umbrellas when the storm breaks out um and so you can sell your umbrellas at a high premium them. So it's, you know, I think it's just the market knowledge, it's the contacts that they have. But the difficulty of the strategy is maintaining it in the most cost effective manner that you can. Because if you're trying to do this from your interactive broker's account, you're probably going to lose a lot of money month after month, year after year. And at some point, most people I think are going to cut and run and say, forget that, you know, I'm losing money and, you know, and they don't have, they either don't have the cash to keep it up or the stomach to keep it up. Talk to me about the risk of ruin. That seems to be one of the things that

really kind of drives, you know, part of their marketing, but also I think across Wall Street, you know, people realize, hey, you can compound capital for a really, really long time. And it It doesn't take that much to just all of a sudden lose it all. And obviously in these market crashes, that's a huge thing. And it's something you talk about throughout the book. Why is that so important, you think, as part of their marketing? Well, I think it's a real risk, especially when you're using leverage. So, you know, if you're in trades that are 30 to 1, 20 to 1, you don't need the market to go down that much to completely wipe you out.

Um, so that's the risk of ruin. It's, it's also known as gambler's ruin. You know, it's like Russian roulette. If you, you know, you can spin the barrel a couple of times and you might live, but if you keep doing it, you're going to blow your head off. And that's kind of what, uh, the ruin risk is, um, is you may survive, uh, you know, like if you go into casino and you put all your money down on red, you might make it a couple times but eventually if you keep doubling down you're going to lose

all your money and that's uh that's the risk they say that they avoid uh with the strategies they cannot blow up and you know that's the trade that originally with empirica uh nassim wanted to devise a strategy that can't blow up it can bleed um and you can lose money over an extended period of time but there's no leverage in it it's just a you know you're buying these options they expire you've you know lost the money on that investment but there's no way that you can in a big downturn um with that strategy that you can lose everything you actually make a lot it's the you know people know nassim's book anti-fragile um i think that he he hasn't told me this but i think that he must have gotten that concept with this strategy

because it's the ultimate anti-fragile strategy these put options uh you know you can lose the money on them but when there's a you know big episode of volatility they become anti-fragile they become extremely valuable it's fascinating to think about the one thing everyone worries about in blowing up they figured out a way to hang their hat and say that's the one thing that we can ensure won't happen right and it's almost this uh again this contrarian nature uh to it um talk about um the 4 400 return so at the beginning of uh covid i think it was in march of uh of covid um they reported uh a universal 4 400 return there was a lot of people who were kind of you know breath taken away and they're like, oh my God, that's an incredible return.

Then there's a lot of critics who were like, that's bullshit. You know, they lost money before and all the critiques that came out. How do you look at that kind of just massive number that they posted in what was one of the most recent, you know, really big market downturns? analytics, and smarter workflows to simplify campaign delivery and access better data across the business. The result? Less time spent on operations, more time connecting brands with the moments and fandoms that matter most. Learn more at Accenture.com slash Spotify. It's probably where most people don't understand how Universa operates and how they report their returns. So a lot of funds typically report, like if they're a $100 billion fund and they went up

to $2 billion, they're going to say, we had 100% return. So Universa is managing, what they are actually doing is they're protecting assets. And when they disclose their AUM, what they're actually disclosing is the amount of assets that they have a protection portfolio on. So if they have, you know, they're protecting $5 billion in assets, it's not like they have $5 billion in the market. They actually have a very small percentage of that $5 billion actually in the market at any given time of just a few percentage points of that. And that position, that sort of overlay on the portfolio that they're protecting, that what that does is that's what the 4,000 plus percent return is on. So it's the return on the options that they had bought

during that period of extreme volatility in early 2020. That's where you get the 4,000 plus percent return. And so what does that look like in terms of if they had $100 in the fund, if there's a few percentage points, let's say they had $1 to $5 actually deployed at the time in those options for 4,400% return that gets them still hundreds of percent on the total capital, but it's not the 4,400% on the entire fund size. Right. Which would be crazy, right? You know, 4,000% on 5 billion. I mean, anybody who knows the strategy, anything about it, they know that that's not what they were saying, but they, you know, people still like to criticize them because either they're, you know, competitors or jealous, or they just like to throw mud at Nassim and Mark.

But, you know, I talked to tail hedge managers and they're, what I think irritates some of their competitors is that they don't report in the same way that Universa does. And they're like, well, yeah, I could have said I made 2000% or 3000% in early 2020. But that's not how we report our returns. And like, okay, you know, that's fine. Universa, you know, is the original tail hedge fund. They created the strategy. And I feel like is, you know, that gives them the right to do report returns however they want. Yeah. What's been the most surprising part? I mean, you've known these guys for a while. As you wrote the book, what was the part that kind of stuck out to you or maybe the biggest insight that you weren't expecting?

I think that, you know, how you can take this worldview that they've learned as a trader, as an asset manager and managing risk and how that can be applied to other parts of the world, like, you know, climate risk is something that I write about in the book, and something Nassim has written about. And, you know, with risks like that, you have, there's these potential extreme events that could happen. You don't really know statistically how likely it is,

but you know the the uncertainty of the potential outcome of these risks is so high that you need to be very careful about managing that risk and i think that you know with black swans in the market um you don't know it's going to happen you don't know that there's going to be a crash but the uncertainty about the potential of it means that you need to be pretty careful about it you know like nassim likes to say if you don't have trust in the pilot don't get on the plane it's the uncertainty of the possibility of these extreme events that people need to take into consideration but it's also uncertainty that causes people to say well you know we don't really know how bad this is why should we take precautions against it because we don't really understand it

that well and you know you saw that with covid in 2020 was there were a lot of people especially early on saying well we need to study this thing more because we don't understand the properties and how contagious it is or how deadly it is so let's just wait and see and uh figure it out and then we can decide what to do and it's that wait and see uh mentality that's the problem is we wait too long and game over you know and uh i think that's part you know partly what uh caused the u.s and other countries to have such you know high fatality rates in 2020 2021 um and you know it's uh i i think that the original idea of the book actually came in early 2020 when i saw what universa did and around the same time nassim and some co-authors had written a paper in january

of 2020, warning about the potential extreme risk that COVID posed and saying, we really need to be careful with this thing. It poses the risk of ruin. Let's take precautions. They were actually in contact with officials at the White House, and they communicated that paper to the White House. And it made me think, like, what is it about Nassim's ability to see the extreme risk posed by COVID that kind of maps over onto what Universa did, because it's, you know, the same time you

have, you know, two people who have been engaged in the same market activities coming out looking pretty smart when everybody else is in total chaos and losing money, not understanding COVID. um that's the thing that i thought you know what is it about their the way that they see the world that enabled them to get through this period of crazy risk and come out looking pretty smart and then when you look at um spitznagel what do you think separates him from kind of everyone else, right? Is it something about the discipline? And, you know, even Nassim kind of said, hey, I don't want to do this anymore, right? I don't want to deal with almost the mundane kind of nature of it. Maybe he didn't want to be the front man, whatever, but like

Spitznagel has stayed with this the entire time. What is it that separates him? Yeah. Well, I, you know, I write about how when he was growing up, he was a very intense kid and apparently like he told me he'd walk around his house uh muttering to himself saying discipline discipline discipline and at the time that was about his uh practicing uh on french horn and he actually became like a you know one of the best french horn players in america and was accepted to juilliard and was going to become a professional french horn player um and then Apparently, his brother told me the story that he found out how much like the first seat French horn player in the New York Symphony made per year. And it was like less than a high school teacher made.

And he said, forget that. uh and it you know around the same time he'd started uh going to the chicago board of trade and just became fascinated with it he just fell in love with it you know i tell the story of how his father one day brought him to the cbot and he it wasn't at all what he expected and he you know the energy of it he just fell in love with it and i think it just something in him clicked that you know it's like this is this is for me like i wanted i want to do this and he just dove into it and it's just all you know i think he's it's just a natural fit he's a he's a natural born trader and uh the discipline that he learned you know under a clip about learning to lose

i think that mentality has separated him from most other uh traders who who do not like clothes um it's also you know i mean if you think about the incentive structures on wall street you you most uh people traders or money managers or whatever they have their eye on their annual bonus um which that's all that matters for them is how big that bonus is going to be year after year. If you're losing money year after year, you don't get a bonus. There's no bonus. So the incentive structures on Wall Street are just designed to pretty much force traders to adopt a strategy that's going to give them steady returns, but they're taking this risk. And I think that, you know, the bet is, well, if I can hang on for five years, you know, and before I blow up, I'm going to do, I'm going to have, you know, a lot of money.

Maybe they can make it longer than that. But that's not the way Universa operates. They, you know, they make their money very incrementally or very, very rarely. and you know i asked uh i asked them you know how do you get your traders to stick with this because they don't have that you know uh incentive of the big bonus at the end of the year and they said the way they get them to think about is like having an option uh for in a company and you know when it goes public you're gonna make a lot you're gonna you know it might be a few years where you're not going to get much of a return. But when those options pay off,

you're going to get a lot. I want to read you a quote. This is a banker talking about a gentleman named Suleiman Olyan. He is one of the richest guys in Saudi Arabia, built a massive conglomerate of a bunch of different businesses. And his banker said the following, you could see clearly that he wanted to be successful. You didn't see him in bars or nightclubs. He was a serious person. he was always looking for new business and he wanted to seize every bit of opportunity that came his way he was almost compulsively ambitious the reason why i thought of that specific phrase is he was a serious person you could clearly see he wanted to be successful like all these points of this banker talking about suleiman is very similar to what you're saying about

mark spitznagel but then it talks about he was almost compulsively ambitious and one of the interesting things about this strategy is, to some degree, you have to temper ambition of doing things outside of the strategy of losing discipline of trying to get too smart or too greedy. And so it's fascinating to me, right? And I think in kind of reading the book of like, you have to be ambitious enough to want to do this and kind of stick with it. But you also have to be self aware enough to know that if you get greedy, if you become undisciplined, you basically ruin the strategy and all of the value you know dissipates very quickly right yeah yeah it's it's a model it's a it's a strategy and you know nasima said he's never seen mark uh stray from the model

once uh the the the protocol as they call the black swan protocol um so he it's it is definitely discipline um and it's i think it's just hard to do and one important thing about the universal strategy uh you know as i point out in the book is this is not designed to be a uh strategy for your whole portfolio no one would put all their money into a universal fund you actually based on the historic returns, you actually would have done pretty well with very lumpy gains. It's meant to be a overlay of a broader portfolio of stocks and maybe some bonds. What Mark says is we recommend our clients that you put 3% into our fund and the rest you can put into stocks. The idea is that traditional portfolios that many pension funds follow is the 60-40 strategy, 60% in the stock

market, 40% in bonds or other less risky assets like maybe some gold and currencies, commodities. The problem with that strategy, according to Mark, is that you're giving up a lot of upside in the market. And that's really where your returns come from. And the market has historically done pretty well. The problem is that the market can be really volatile sometimes and go down a lot. So if you protect yourself during those volatile times and you have a trade that will give you this big infusion of cash when everything is down and are more attractive, that you're going to do pretty well over time. And that's basically, in a nutshell, what their strategy is.

It's fascinating when you see how long they've been doing this. And you mentioned that there's a lot of people on Wall Street that have started to kind of wake up to this. Do you anticipate that there will be many, many more copycats, including could we see a BlackRock or other types of, you know, fidelity, like very, very large asset managers start to introduce these strategies as well? um they you know some are and there's some etfs that are coming out uh i somehow suspect that if the market continues to be pretty calm and and you know trade up and down but you know not

the volatility that we saw in 2020 i kind of bet that you know the popularity of the trade is going to fade. And as we've seen before, I mean, after 2008, a bunch of copycats jumped in and launched their tail hedge funds and hung around for a few years. It's just the nature of this strategy that it's very tough to maintain over a long period of time. So we'll see. I mean, you know, universes obviously attracted a lot of money and that's going to cause people to say, hmm, I like those management fees. So yeah, there might be some more, but we'll see. I'm a bit skeptical.

Scott, Chaos Kings is the name of the book, How Wall Street Traders Make Billions in the New Age of Crisis. It is not only fascinating from education standpoint, I think that one of your skills is you also write in a very entertaining fashion so people can kind of read it and you just keep wanting to read more and more.

I really enjoyed this book. So anyone who wants to go pick it up, Chaos Kings, Scott Patterson, I highly suggest you do that. I'm assuming you can buy this Amazon or any of the various books, also audio book, e-book, or physical book. But, Scott, if somebody wants to find you on the Internet or kind of follow up with you on anything you talked about today, where can we send them? Yeah, I'm on Twitter, at Patterson Scott. I've got a website, scottpattersonbooks.com. and uh yeah if you find the book on amazon or uh barnes and noble forever awesome well listen i really appreciate you taking the time to do this uh as i mentioned the book is fantastic so i

appreciate you entertaining me for a couple hours as i uh as i read it and uh we'll definitely have to bring you back when you write the next one we'd love to