We Study Billionaires - The Investor’s Podcast Network - TIP558: How Ackman & Taleb Profited Billions During Market Crashes w/ Scott Patterson

Starting point is 00:00:00 You're listening to TIP. On today's episode, I'm joined by Scott Patterson. Scott has been a reporter for more than two decades, mostly at the Wall Street Journal. He just published a new book called The Chaos Kings, which showcases a deep dive into the world of hedge fund managers and traders that profit tremendously during times of calamity. For example, during the COVID crisis, Bill Ackman had a $27 million bet that turned into over $2.6 billion. The Chaos Kings largely highlights a hedge fund run by Mark Spitznagle and Nassim Teleb. These two have profited tremendously from Calamity for many decades.

Starting point is 00:00:40 Teleb saw his first big success during the 1987 Black Monday crisis, and these two joined forces in the hedge fund industry in 1999. In this episode, we cover who the Chaos Kings are, the story of Teleb and Spitznagle setting up a hedge fund that delivered average annual returns of over 105%. Yes, you heard that right. Average annual returns of over 105%. How these hedge funds managed to profit tremendously during times of calamity. What led Nassim Taleb to get interested in the markets in the first place? Why we should be mindful of just how uncertain the world is and our global economy is today?

Starting point is 00:01:19 How investors can protect themselves from a Black Swan event? How predictable black swan events are for these traders? Looming Black Swans that Taleb sees in today's world. so much more. I thoroughly enjoyed this conversation with Scott, and I hope you enjoy it as well. With that, here's my conversation with Scott Patterson. You are listening to The Investors Podcast, where we study the financial markets and read the books that influence self-made billionaires the most. We keep you informed and prepared for the unexpected. All right, hey everyone, Welcome to the Investors podcast. I am your host, Clay Fink. And on today's episode, I am absolutely thrilled to be joined by Scott Patterson. Scott, thank you so much for coming on the show today. Yeah, thank you for having me.

Starting point is 00:02:17 Well, Scott, I brought you onto the show to chat about your new book, The Chaos Kings. And I absolutely love that you wrote this book because it highlights the importance of considering these extreme tail risk events. And just when that word comes up, I just have a handful of things. automatically come to mind. You know, you think about geopolitical tensions, AI, and then you think about just our increasingly fragile financial system. I think a good place to start this conversation is just to simply ask you, who are the Chaos Kings? The Chaos Kings, it's a term that I came up with in this book to describe a group of traders or investors who have managed to in various situations benefit and actually prosper during times of chaos. They see something coming that looks risky and dangerous and they make trades that can benefit from it. Or the people that I mainly profile, Mark Spitznagel and Nassim Teleb of the Black Swan fame, they are constantly trading around

Starting point is 00:03:19 the risk of chaos in the markets. So there's different varieties. There's some that use very advanced physics techniques to try to predict when something crazy is going to happen. There are others that just use their sort of gut instinct, like Bill Ackman, who I profile in the opening section of the book, who in January of 2020 saw what was going on with COVID-19 and was really freaked out by it. And he understood the nature of the risk that the pandemic posed before many others did. So he was able to enter these trades very cheaply because other people weren't recognizing the risk and ended up making billions of dollars when things went south. So, Ackman kind of, he really highlights one of the key traits of this Chaos King trading strategy,

Starting point is 00:04:12 which is you have to panic early. And panicking isn't a thing that you usually want to associate with investing or trading. But in these situations, it actually sometimes is good to panic because if you don't, if you wait, if you try to assess the risk in the situation, it's going to get ahead of you and you're going to be too late and you're going to get run over. Similarly, in the mid-2000s, there were hedge funds that saw what was going on in the housing market and the derivatives markets. They were able to trade earlier than others very cheaply and get into these positions that ended up making billions of dollars. So these are very profitable trading strategies because of the nature of the risk that happens

Starting point is 00:04:53 and the cheapness with which you can enter these trades can create these explosive returns. And that's how Mark Spitznagle explains his strategy, which is explosive upside return. You can buy something for a derivative, an option contract, say, for 40 cents. And when the volatility really hits the fan, you can sell it for $60.

Starting point is 00:05:12 And that's something that they have done. So that shows you how that's a crazy, you know, sort of out of this world gain. that can be made on these trades. It's interesting you mentioned Acman there. He made $2.6 billion, I believe, on the drawdown in COVID. But the interesting thing about Spitznagel is that he's profited from these downturns over and over and over again. So he's kind of figured something out that a lot of other people haven't.

Starting point is 00:05:37 And I think about how most investors, they kind of ignore the possibility of calamity or they expect to weather through it by just hanging on to their investments. And then Spitznagle is looking to actually thrive when that calamity and that chaos strikes. To give more background on Spitznagle, he launched a hedge fund with Nassim Thaleb in 1999. And then they ended up shutting that down in 2004. And then Spitznagle very timely relaunched that in 2007 to, again, try and profit on these swift drawdowns. So could you expand a little bit more on how Spitznagle was thriving in these times of calamity? Yeah. So as you said, the strategy got its start in 1999 with the launch of Empirica. And Mark and Nassim, they met each other at New York University. They'd both been sort of dabbling in these strategies where you buy derivative contracts and you'd buy them very cheaply. And then when the chaos hits, you benefit a lot. So Mark had done that. Nassim had done that through some of the big dustups in the 1990s, like that. the Asian flu. They had both benefited from that. So when they met, they kind of, it was a great meeting

Starting point is 00:06:48 of the minds of two people who were discovering similar attributes in the market that these investments could be got into very cheaply and they had these explosive returns. So they launched Empirica and it really was the first so-called tail risk hedge fund ever created. It wasn't designed to invest in the stock market. They didn't invest in commodities. They only did one thing. They entered positions that would have this explosive upside risk in major downturns. The trouble with the strategy is that when things are normal, it loses a little bit of money every day or every month. So you can go through these fallow periods where you're not really making a lot. It can be tough emotionally to go through that. So they did very well in 2000,

Starting point is 00:07:35 2001 during the dot-com blow up. But then things settled down when, you know, green span, lower interest rates, volatility went down. And Nassim just got very frustrated with this day-to-day bleeding, as they call it. It sounds kind of painful. It's emotionally challenging to go through that. So he ended up deciding to shut the hedge fund down. He thought it was bad for his health. Mark thought he was crazy because he really believed in the strategy.

Starting point is 00:08:00 He thought they had something totally unique, which they did. And he just thought Nassim was making a big mistake. So he took a few years off. He did some other things. at Morgan Stanley for a while, but all the time he was sort of thinking about how to refine the strategy, how to make it better, more efficient. So in 2007, he relaunched, as he said, good timing. He did have a sense that, you know, maybe this was the time to do it. And coincidentally, he was the same year that Nassim published the Black Swan. So both of them had very good timing.

Starting point is 00:08:31 The Black Swan, you know, as everyone knows is about extreme events, not only in the markets, It's been in the world and how people tend to discount these extreme events. They prefer to not think about them. You know, there's all sorts of behavioral things that come into play with that. We have, like, recency bias. So we think what happened yesterday is going to be what happens tomorrow. That's just not how the world works, but it's how people work. It didn't rain yesterday.

Starting point is 00:08:57 I'm not going to need an umbrella today. That's how I am. So they launched in 2007, and the scene wasn't involved in direct day-to-day trading as a firm. He did provide some advice to it from time to time, but mainly he was, especially with the fame that he got with the Black Swan, he helped provide visibility to Universal. But it really didn't catch on. They had a couple initial investors when they launched, but Mark, he traveled the country in 2007, early 2008, making his pitch. And nobody wanted it. Nobody wanted to invest in Universal, despite all the signs that we were seeing a lot of.

Starting point is 00:09:37 of volatility. And the reason for that is the returns of a hedge fund like Universal are very lumpy. And for normal investors, that's not good. Modern portfolio theory really likes trading strategies that have steady returns, low volatility. You kind of know what you're going to get. Universa, you lose money year after year. And then you make a billion dollars. But to most investors, pension funds, whoever they were pitching it to, they didn't like it. It was a line item for them. It was a loss. You know, losing millions of dollars a year. It's hard to justify that to the board of these funds. Something so weird, it was just completely unique. Then around mid-2008, things started getting a little crazy. The September 2008

Starting point is 00:10:25 collapse of Lehman Brothers, Fannie Mae, Freddie Mac, AIG, you know, all those things blew up. And all of a sudden, Universal was making massive games. you know, 100% of their portfolio up 100%. So that got them a lot of attention. I was the reporter who first broke the news about the returns. Actually, I broke the news of Universe's launch in 2007 and also that Nassim had shut his hedge fund down in 2004. So I've known them for a long time

Starting point is 00:10:58 and I've been following their performance for a long time. And they remain controversial, but they created an entirely new, investing strategy and how many people can say that. It's funny when Spitznagle relaunched that fund. In your book, you described it as what investors called the Goldilocks period where markets were really calm and things seemed to be well under control. And investors really became complacent. And then when I hear about these investors that do really, really well, in my mind, it's all about finding the mispricings in the market. And, you know, they're able to buy

Starting point is 00:11:33 options that are extremely cheap, that ended up eventually becoming extremely valuable. They may not know the timing of when that happens, if it's this year, next year, the year after. But eventually it happens and they get that strong outperformance. The really interesting part of this is that despite their strategy being somewhat well-known, there were a lot of copycats that weren't able to get near the results that they did. So what do you think was different from their strategy than the copycats? I wish I knew, you know, then I'd launch my own Hell Hedge fund. You know, I've talked to Mark about this a lot. What is it that they do? And he says it's trial and error. We've been doing this for decades. We really know the market. We know what we're doing. You know, since they've been around so long, they're known on the street as a firm that will do these trades that hardly anybody else normally wants. Their trades are bets on a one month decline in the S&P 500 of 20%, which is, kind of crazy, you know, because that doesn't happen very often, obviously. But they enter those

Starting point is 00:12:35 trades time and again, and the counterparties, the firm selling those trades, just see that as steady revenue. You know, yeah, these nuts over here, they're betting on this thing that we know is not going to happen. That's millions in our pockets. So they have developed these relationships with the counterparties and the brokers on Wall Street. They're sort of like a market maker for these kinds of options that few others want to buy. So I think that's part of it. They have a sort of first mover advantage. You know, I think also there are other strategies that they employ that lower their cost.

Starting point is 00:13:09 Because basically, at the end of the day, this strategy lives and dies on the cost of entering these trades. The clients give them the money. They go out. They build the portfolios of these far out of the money options, put options. And the cheaper you can do that, the longer you. you can last, the cheaper it is for your clients. So one thing they do is they actually sell options that are more near the money to the current price of the stock that they think are more accurately priced or they might actually be able to make a profit on those trades. So that helps

Starting point is 00:13:44 bring down the cost structure of the strategy. That's a thing that I would obviously have no idea how to do. I wouldn't recommend your listeners try to do that either. So, and it's also why this isn't a strategy for everyday investors. If everyday investors try to replicate this, they would over the long run probably lose money because it's, you know, you have to keep rolling over the trade. And more likely than not, people who think they're going to do this, they're going to end up spending money for six months or a year and think like, this is stupid. I'm losing all this money. I'm not making anything. And that's what you, you have to overcome that instinct. You have to keep doing it, waiting for, you know, could be years when it finally happened. And it finally

Starting point is 00:14:25 happens, you make a ton of money when everybody else is losing that has multiple benefits because you've suddenly got this infusion of cash when everyone around you is losing cash and the market's down and you can buy when there's a blood on, literally when there's blowing streets. It's a sort of a Buffett-like strategy in some ways. He waits till things are really bad for everybody else. He's got all this dry powder and he goes in and gets these great deals. And Spitznagle actually sees himself is sort of like a value investor. These options are, he believes, they're dirt cheap, underpriced, he thinks, according to the risk. And, you know, he's buying them.

Starting point is 00:15:05 Normally they expire worthless. They're junk. But sometimes they're a gold mine. One of my favorite parts of the book was the involvement of Nassim Taleb, despite Spitznagle kind of being the brains behind the strategy. I wasn't too familiar with Taleb's background prior to him writing these best-selling books. So could you talk about sort of what? what he was up to prior to getting involved with Spitznagel and then how they met and then

Starting point is 00:15:31 eventually launched this strategy? Yeah, Teleb was born in Lebanon and he was growing up in Beirut when the war broke out there in the 80s. So, you know, he had sort of an up-close look at how a normal world can suddenly deteriorate into total chaos and war. He moved away in his teens and, you know, studied business in France for a while. then he came to America and went to American universities. He was born in business school.

Starting point is 00:15:59 I was one place he attended, and it was there that he learned about options. He told me. And he really grew, I mean, it's kind of weird to think about it, but he really grew fascinated by these things that I think to most people would just seem really boring. But he looked at him and he thought there are strange properties to these options that a lot of people don't really understand. So then he started trading on Wall Street, working for various.

Starting point is 00:16:24 firms, trading options. He was really good at it. At one place, he became known as the Bobby Fisher of Options, an homage to the famous chess player. And then in 1987, he found himself at First Boston on the trading floor in Midtown Manhattan. He had been, you know, dabbling in options and other derivative contracts. And, you know, one thing he started doing was buying these really cheap positions on options on euro dollars. I'm sure your listeners don't want to know what those are, but like futures contracts on euro dollars. And he had built up this big position, you know, on these zero dollar contracts, very cheap contracts. So Black Monday comes along in October 1987. Everybody gets wiped out. He's there on the floor. This is a scene I'd, you know,

Starting point is 00:17:14 describe in the book. People are just crying and freaking out. His boss is sitting there at his desk, begging the numbers to stop moving. And, you know, everybody's shell-shocked. Nassim's positions are doing pretty good. He's looking around and saying, well, you know, he didn't really know why at the time it was so chaotic. People didn't even know why the market had crashed so much. So that was Black Monday, but his positions didn't really take off until the following day when the Federal Reserve infused billions of dollars into the financial system. And it had this weird effect on the contracts that Nassim owned that they went parabolic, which means like up like a rocket. So, you know, he told me about how he was looking at his positions and he was saying,

Starting point is 00:17:59 you know, stuff he bought for 50 cents, calling to the floor broker saying, sell for 300. And the broker would call him back and say, sold for 350. And sell for 400, sold for 450. And it went on and a law like that. And this was a move that is just not calculable in these contracts. It shouldn't have existed in the history of the universe. You know, they're so far out of the realm of statistical probability that you can't even really calculate it. So that's when he really got this lesson on how the normal parameters and probabilities that Wall Street uses to measure the risk and potential profit of various strategies,

Starting point is 00:18:40 which is totally off. At the time, he wasn't really sure what was going on, but it definitely intrigued him. So he continued to, you know, research it, pursue these trades. He ended up in the 90s writing a sort of technical book about trading derivatives that explained his pursuit of, you know, trying to understand why this stuff happened. And then, you know, in 1999, he launched Empirica with Spitznagle. But he always comes back to Black Monday for him. He just constantly brings that up and says it was the greatest trading day of his life.

Starting point is 00:19:12 And it, you know, made him rich. And so, yeah, that was the seminal of that. Let's take a quick break and hear from today's sponsors. All right. I want you guys to imagine spending three days in Oslo at the height of the summer. You've got long days of daylight, incredible food, floating saunas on the Oslo Fjord, and every conversation you have is with people who are actually shaping the future. That's what the Oslo Freedom Forum is.

Starting point is 00:19:37 From June 1st through the 3rd, 2026, the Oslo Freedom Forum is entering its 18th year, bringing together activists, technologists, journalists, investors, and builders from all over the world, many of them operating on the front lines of history. This is where you hear firsthand stories from people using Bitcoin to survive currency collapse, using AI to expose human rights abuses, and building technology under censorship and authoritarian pressures. These aren't abstract ideas. These are tools real people are using right now. You'll be in the room with about 2,000 extraordinary individuals, dissidents, founders, philanthropists, policymakers, the kind of people you don't just listen to but end up having dinner with. Over three days, you'll experience

Starting point is 00:20:21 powerful mainstage talks, hands-on workshops on freedom tech, and financial sovereignty, immersive art installations, and conversations that continue long after the sessions end. And it's all happening in Oslo in June. If this sounds like your kind of room, well, you're in luck because you can attend in person. Standard and patron passes are available at Osloof Freedomform.com, with patron passes offering deep access, private events, and small group time with the speakers. The Oslo Freedom Forum isn't just a conference, it's a place where ideas meet reality and where the future is being built by people living it. If you run a business, you've probably had the same thought lately. How do we make AI useful

Starting point is 00:21:04 in the real world? Because the upside is huge, but guessing your way into, it is a risky move. With NetSuite by Oracle, you can put AI to work today. NetSuite is the number one AI cloud ERP, trusted by over 43,000 businesses. It pulls your financials, inventory, commerce, HR, and CRM into one unified system. And that connected data is what makes your AI smarter. It can automate routine work, surface actionable insights, and help you cut costs while making fast AI-powered decisions with confidence. And now with the NETSuite, NetSuite AI connector, you can use the AI of your choice to connect directly to your real business data.

Starting point is 00:21:44 This isn't some add-on, it's AI built into the system that runs your business. And whether your company does millions or even hundreds of millions, NetSuite helps you stay ahead. If your revenues are at least in the seven figures, get their free business guide, demystifying AI at netsuite.com slash study. The guide is free to you at net suite.com slash study. NetSuite.com slash study. When I started my own side business, it suddenly felt like I had to become 10 different people

Starting point is 00:22:14 overnight wearing many different hats. Starting something from scratch can feel exciting, but also incredibly overwhelming and lonely. That's why having the right tools matters. For millions of businesses, that tool is Shopify. Shopify is the commerce platform behind millions of businesses around the world and 10% of all e-commerce in the U.S., from brands just getting started to household names. It gives you everything you need in one place, from inventory to payments to analytics. So you're not juggling a bunch of different platforms.

Starting point is 00:22:47 You can build a beautiful online store with hundreds of ready-to-use templates, and Shopify is packed with helpful AI tools that write product descriptions, and even enhance your product photography. Plus, if you ever get stuck, they've got award-winning 24-7 customer support. Start your business today with the industry's best business partner, Shopify, and start hearing sign up for your $1 per month trial today at Shopify.com slash WSB. Go to Shopify.com slash WSB. That's Shopify.com slash WSB.

Starting point is 00:23:25 All right. Back to the show. Now, Taleb, when you're talking about him in your book, he stated that, or he believes that financial markets and the economies that depend on them have become increasingly complex, unstable, and prone to crashes. He very much believes that we live in a world with increasing fragility and increasing uncertainty as time progresses. And many investors are underestimating the level of risk and fragility in the overall system. What are some of the things you think are going through his mind for why he so strongly believes this? And what are your thoughts on why we need

Starting point is 00:24:00 to maybe be aware of just how fragile and uncertain our world is today. Yeah, there's a couple reasons why he thinks that it's all really interesting. Some of it comes back to complexity theory, which he really started reading a lot about in the 2000s, and he got to know some very prominent complexity theorist. And it's hard to say what complexity theory is. It's got multiple definitions, but it's basically the study of the interconnections of various properties and phenomena and economies and risk systems and financial markets. And part of the idea is that as systems become more complex, more interconnected, they can become more fragile.

Starting point is 00:24:43 As like one part of the system breaks down, it sort of ramifies through the system and hits the rest. So the whole, you know, you pluck one piece of the spider web and the whole thing comes down. So that's kind of the core of it is that the global economy and the financial system is more interconnected than ever. And I think that 2008 was a perfect example of that. You saw one part of the world economy, the U.S. housing market declined, which was not expected. But if it had just been a decline in the price of houses in the United States, you've not seen any global financial crisis. The financial system was all connected through these derivatives. I don't know if people remember, you know, endless stories about credit default swaps and

Starting point is 00:25:28 collateralized debt obligations and how they're all bundled together. And, you know, all the banks had bought them and they had sold them to pension funds. So through complex interrelationships in the financial system, a, you know, sort of blip in one part of the economy triggers sort of these explosions all throughout it that, you know, threatened to take it down the entire. economy. You think about COVID-19, that was something that it definitely was global, but, you know, we haven't seen anything like that in such a long time. And something that Taleb and others have been warning about is that the risk of a pandemic spreading in ways that they'd never done before

Starting point is 00:26:08 is higher than ever because of global interconnectivity through at least mainly increased plane travel. So you saw this outbreak in Wuhan, China, maybe in previous outbreak. it could have been contained. But China is a very interconnected society. People travel a lot. Before the lockdown in Wuhan had been implemented, five million people had left the region. So it spread very quickly,

Starting point is 00:26:33 despite efforts, obviously, to contain it. It was uncontained, and it spread throughout the globe. That pandemic caused the global economy to seize, essentially just seize up and stop. And, you know, we're still feeling the ramifications of that through inflation and issues with the supply chain that are getting worked through.

Starting point is 00:26:53 But those are two examples of how increased complexity, interconnections, and society is leading to more fragility and financial risk. Your book talks quite a bit about black swans. And black swans, it's almost this phrase that just gets thrown around all the time. There's a black swan every other year now it feels like. And like I mentioned, it almost seems to be like a feature of today's increasing. fragile economy. So I'd love to get your thoughts in general on, you know, how people can avoid being blindsided by black swans. And is it true that like black swans really can occur every year?

Starting point is 00:27:30 Or I believe there's another term, I don't know if it's gray swan where there's these, you know, kind of tail risk events, but it's not, you know, a fat tail far out on the, the bell curve. What are your general thoughts on this? Yeah, it's definitely sort of, there's a frustration to it to defining what a black swan is. I know that Nassim, feels the frustration because it's, you know, I remember a debate that he was having with somebody who was challenging his conception of black swans. And he said, look, it depends on where you stand. Was 9-11 a black swan for the terrorist? No, because they could see it coming. Was it a black swan for the pilot? Yes. So there are some complexities around it.

Starting point is 00:28:09 And people endlessly debate, like was the global financial crisis? A black swan? Teleb would say, no, it was a gray swan, as you said, something that he had. predicted. He had, you know, he was on record as predicting the failure of some of the big mortgage lenders like Fannie Mae. I don't know if he had predicted quite the collapse that we saw because you would have had to really know how thoroughly these derivatives have been spread through his financial system. Now, there were some people who did see that, who, you know, people like profiled and Michael Lewis's book The Big Short who actually were aware. So it kind of depends on who you are if something is predictable or not. For most people, I think it was a black swan. So in terms of

Starting point is 00:28:55 how to protect yourself, it's pretty tricky. And it's something that I sort of endlessly went over with my editor was, you know, on this book was tell people how they can protect themselves from black swans. It's not easy. So it's hard for, especially, you know, everyday investors. What I would say is you have to be, if you're going to be investing, you have to be humble, you have to be a of the potential for big drawdowns and try to not take positions that are vulnerable to those kind of events. So I would say don't invest in a bunch of risky startups, play it safe. And you can't do a universe strategy that's just, you know, I was saying earlier, it's just so hard to replicate that. But historical record shows that really the safest investment that you can make over the

Starting point is 00:29:44 long run is a very simple strategy. You invest in the S&P 500 and you hold on to it over the long run. You will get hits, but you're not going to blow up. And that's where hedge funds and other you know, like derivatives traders make mistakes and blow up. They literally lose all of their money in these events. We saw some catastrophic blowups in 2020 very quickly. These firms can lose all their money in a day because they were not positioning themselves to be able to weather the extreme events. They were making very risky bets that were based, you know, predicated on things happening day to day as they normally do. And then something crazy happens. They're like, oh, well, you know, we couldn't see that coming. You know, who could see a pandemic? But the point of

Starting point is 00:30:32 Teleb and Svzenegle is you kind of always have to be worried about that. You never know when it's going to come. A black swan is totally unpredictable. And it seems. definition of us and can happen very rapidly. You just had no idea this is going to happen. So I think the idea is just to try to avoid taking too much risk. Certainly do not use leverage or borrowed money. You know, there's a lot of people out there that are day traders. They've become day traders. With the pandemic, people were staying home, had nothing to do. And, you know, like all of these, the sports better started getting into dabbling and day trading. I mean, I may sound, you know, like a grumpy gus or something, but to me, I think it's just a huge mistake to try to day trade.

Starting point is 00:31:15 The record shows that nobody is any good at that, you know. I could count on a single hand number of investors who've been able to beat the S&P 500 over the years. Warren Buffett in 2007, he made a bet against hedge funds over the next 10 years. He bet that the S&P 500 would outperform this basket of hedge funds over the next decade. And I kind of thought at the time, like, wow, that's, you know, hedge funds had actually been doing really well. You know, many had actually beaten the market in recent years. It was a pretty steady time post.com bubble.

Starting point is 00:31:48 Buffett was right. In that 10 years, the only year that hedge funds did better than the SEP 500 was 2008. And the SMP ended up gaining something like, I forget the exact numbers, but 140% compared to 36 or 37% for hedge funds. And these are hedge funds, you know, they're getting paid millions of dollars. is they're getting rich off fees, and they can't be what your Aunt Molly is going to do if she puts her money in a Vanguard S&P 500 index. And that's just been the way it's been, you know, so Spitznagle in the past few years, he's been analyzing various strategies that are popular with hedge funds, like some money in SEP 500,

Starting point is 00:32:28 some money in gold, some money in Swiss francs, bonds, looked at all sorts of permutations of these strategies. none of them over the period that he was looking at, I think since 2008, has beaten a simple investment in the S&P 500, except Universal, which has actually beat it. What were Universa's average annual returns? They had audited annual returns through 2019 of over 100%, which is kind of insane because some of those years they lost money, but when you have a gain of 4,000%, which was actually after that audit, that kind of makes up for a lot of the down year.

Starting point is 00:33:04 I pulled this quote from your book, Black Swans are by nature, undefinable, uncontained, incomprehensible, unpredictable, uncertain, chaotic, random, wild, out-of-control crises. It reminds me of what you're talking about there, how a lot of hedge funds, they'll do things like lever up or push into riskier assets to try and juice the returns. And it looks really good maybe for a few years. And it looks like, you know, things are all fine and well. And then all of a sudden that event hits, that's just totally unexpected and they just get blown up. And I think that's a big reason why Teleb and Spitznagle, they see the possibility of these things happening. And they're just like, yeah, number one thing is capital preservation for them. Yeah, absolutely. Risk management, it's entirely

Starting point is 00:33:47 different from, you know, people try to look at the strategy and say, well, this is, it's not making money all these years and that's no good for investors. They are not speculators. They're not making bets on the direction of the market. They have a risk management strategy. strategy that is aimed to preserve the capital of their investors to the maximum extent that they possibly can. I think that it is one area that confuses people about their strategy because if you, yes, they have actually done a lot better if you just put money in a universe of fund, you would have done pretty good. But that's not what they tell people to do, their own investors. Their strategy is that you clients put in about 3% of their capital into the universe of fund and then the rest optimally in the S&P 500. They can do whatever they want with that other 97% obviously.

Starting point is 00:34:35 But what they do is they just use that as sort of a proxy for the investment in this universal strategy would do. And that is in contrast other risk management strategies, like the most popular strategy is so-called 60-40, which is 60% in stocks, 40% in bonds, which has performed terribly in the past few years. I think 2022 is the worst period on record or in many recent years for that. strategy. It had worked okay in other years, though. The bond portfolio, bonds go up when stocks go down typically. So, you know, you've got a hedge there. But what Spitznagle will say is you're giving up a lot of upside potential in stocks when you do that. When you just have 60% of stocks, 40% of bonds, you're missing out on a massive potential upside. And market generally, you know, historically goes up. It has these really rough patches. And that's the strategy is to,

Starting point is 00:35:32 when you have the rough patch, protect yourself, and that's all that matters. You don't need to trade around the little 5, 10% wobbles. You just need to protect yourself against the 40% or 50% downturn. And Mark has an interesting way of describing why those big downturns are so bad for long-term performance portfolio. So say you have $100, the market goes down 50%. You have lost $50. You now have $50 to get back to where you were. to $100, you have to go up 100%. So down 50%, you need to get back even. You need to go up

Starting point is 00:36:09 100%. So that's why you don't want to have that. It'll take years sometimes to crawl out of that hole. And that's what University tries to do is protect the investors from the big drawdowns, the little wobbles. The market will work itself through that stuff. And that's kind of what in a seem, you know, I was talking to a risk manager, Aaron Brown, who's known them for a long time about how Nassim kind of, and Mark, too, but mainly Nassim with his books, an analysis of typical Wall Street risk management strategies is, you know, Quants risk managers, typically they focus on the day to day, you know, and they think that if you manage those day-to-day risks, well, position the portfolio optimally for those day-to-day ups and downs. That's what

Starting point is 00:36:55 you really need to care about. And you know, you might spend a little time thinking about the Black Swan, the crash, but those are really largely seen as unmanageable. You know, what can you do? You know, these things are crazy. You can't really think about that too much. Whereas, you know, what Aaron said is what Nassim showed is that's really all you need to care about is those the big drawdowns. If you can get through those, then you'll be okay. Because if you can't, you're dead and you're off looking for a new job. It's very clear that Teleb and Spitznagel just thought a lot differently and they just viewed the world totally differently. And one of the things I always find interesting with people like these two is that oftentimes they're very critical of some of the things that are taught in academia, such as the efficient market hypothesis or modern portfolio theory.

Starting point is 00:37:43 What were some of the things you found from these two when they were critical of what was taught in academia? Yeah. Well, Nassim's thinking is books, they've had a big influence on me, you know, for a long time. I came into writing about finance as a, you know, I had a master's degree in English. I studied anthropology and not studied economics or economic theory, but I started writing about finance in the late 1990s and started reading more about the theories behind it, the efficient market hypothesis, which you talked about. And these are sort of predicated on the set. the rational man that's sort of at the, you know, that goes back to Adam Smith, that economies are based on people acting in their self-interest rationally, and you get this sort of optimal economy when everybody's doing that. And then this was taken by finance professors and applied to the market. So the market itself is always optimally efficient every second of the day because everybody is sort of rationally pricing in their expectations of where stocks are going to go or whatever commodities. And I thought that was crazy. I just sort of coming at it

Starting point is 00:38:58 from a completely different perspective, reading novels and stuff. I thought people are completely irrational. They don't behave in sane manners all the time. And now you're talking about financial markets where it's people's livelihoods that are at stake. And I looked at markets and I see fear and greed. And fear and greed, when you think rational, that's not, you know, so yeah, lots of times the market is acting pretty normally. But when Amazon is going to the moon, everybody piles in, it makes no money for years and years. Is that rational? You know, because stock prices are supposed to be for projections of future earnings for investors. Amazon made no money for years and years. So I, you know, somebody who I also read a lot was

Starting point is 00:39:44 George Soros' books. And he definitely does not believe in rational investors. He thinks that markets are driven by, you know, all sorts of strange factors that are sort of interconnected. And he would say Amazon, it wasn't rational, but there was sort of this self-fulfilling prophecy in what happened to that stock because the stock price goes up. The company can use that high stock price to buy other companies compensate managers who might think that they can get a better deal at Amazon. But that's not rational expectations. So, you know, when I met with Nassim in, 2007, that's when I got to know him, it really, what he was saying really clicked for me. These models that Qantas use are based on the bell curve, things all clustering in the

Starting point is 00:40:34 middle of the curve. He was saying, like, no, it's the stuff on the back tails of the curve. That's what really matters. But their models just cut that out. They just say, no, we're not going to worry about that. Five percent risk that, you know, we could lose all our money in a day. Let's take a quick break and hear from today's sponsors. No, it's not your imagination. Risk and regulation are ramping up. And customers now expect proof of security just to do business. That's why Vantza is a game changer. Vanta automates your compliance. process and brings compliance, risk, and customer trust together on one AI-powered platform. So whether you're prepping for a SOC 2 or running an enterprise GRC program, VANTA

Starting point is 00:41:16 keeps you secure and keeps your deals moving. Instead of chasing spreadsheets and screenshots, VANTA gives you continuous automation across more than 35 security and privacy frameworks. Companies like Ramp and Ryder spend 82% less time on audits with VANTA. That's not just faster compliance, it's more time for growth. If I were running a startup or scaling a team today, this is exactly the type of platform I'd want in place. Get started at vanta.com slash billionaires. That's vanta.com slash billionaires. Ever wanted to explore the world of online trading, but haven't dared try? The futures market is more active now than ever before, and plus 500 futures is the perfect place to start. Plus 500 gives you access to a wide range of instruments, the S&P 500, Nasdaq, Bitcoin,

Starting point is 00:42:09 gas, and much more. Explore equity indices, energy, metals, 4X, crypto, and beyond. With a simple and intuitive platform, you can trade from anywhere, right from your phone. Deposit with a minimum of $100 and experience the fast, accessible futures trading you've been waiting for. See a trading opportunity, you'll be able to trade it in just two clicks once your account is open. Not sure if you're ready, not a problem. Plus 500 gives you an unlimited, risk-free demo account with charts and analytic tools for you to practice on. With over 20 years of experience, Plus 500 is your gateway to the markets. Visit Plus500.com to learn more. Trading in futures involves risk of loss and is not suitable for everyone. Not all applicants will qualify.

Starting point is 00:42:58 500, it's trading with a plus. Billion dollar investors don't typically park their cash in high-yield savings accounts. Instead, they often use one of the premier passive income strategies for institutional investors, private credit. Now, the same passive income strategy is available to investors of all sizes thanks to the Fundrise income fund, which has more than $600 million invested in a 7.97% distribution rate. With traditional savings, you'll, it's falling, it's no wonder private credit has grown to be a trillion dollar asset class in the last few years. Visit fundrise.com slash WSB to invest in the Fundrise income fund in just minutes. The fund's total return in 2025 was 8%, and the average annual total return since

Starting point is 00:43:47 inception is 7.8%. Past performance does not guarantee future results, current distribution rate as of 1231, 2025. Carefully consider the investment material before investing, including objectives, risks, charges, and expenses. This and other information can be found in the income funds prospectus at fundrise.com slash income. This is a paid advertisement. All right.

Starting point is 00:44:11 Back to the show. Another interesting idea related to Teleb is the title of one of his books, Skin in the Game. You talk a bit in your book about how lack of skin in the game and the financial system also leads to this increasing fragility into the overall markets. So I'm curious if you could expand on this idea as well. Yeah. I think Nassim really developed that idea after 2008 when, you know, all of these very highly paid managers of banks and hedge funds, mainly banks, I think, is what he was looking at, lost all the money and yet walked away with millions and

Starting point is 00:44:49 millions in pay packages and were bailed out by the government. One person he likes to really focus on is Rob Rubin, who was chairman of Citigroup through the 2000s. And he got, I think, $100 million dollars from Citigroup. And yet that bank collapsed and required billions and billions and bailouts. And Nassim says that happens because these managers don't have so-called skin in the game. So which to him would mean if the bank collapses, the managers are on the hook for that personally. Their own bank accounts are on the hook and will be required to help repay investors or clients. And he thinks probably rightly that if that were the case, they wouldn't be taking all these crazy risks because they're basically socializing the risk to the rest of the country by saying, if I can take all these crazy risks. because they're basically socializing the risk to, you know, the rest of the country by saying,

Starting point is 00:45:46 if I can take all these crazy bets year after year, I get a big bonus. Yeah, eventually it may blow up. By then, I've got my private yacht and Island and the Caymans and I'm fine. You know, so I, and I think that, you know, right now people are looking at these regional banks that are collapsing from like Silicon Valley Bank and thinking the same thing, like, you know, these managers, either they didn't understand the risks they were taking or they made the gamble that it was worth it to hopefully get through any short-term volatility that they could survive that. Obviously, they didn't, but the bankers are not on the hook for that.

Starting point is 00:46:27 So, this seems to contrast that with hedge funds, which often the partners of the hedge funds do have a significant amount of their own wealth in those strategies. and that constrains the risk they take. I don't really know. I mean, I see a lot of hedge funds blow up. So I think that sometimes the greed side of the spectrum overcomes the fear side a lot. And, you know, they just either don't understand the risk

Starting point is 00:46:53 or they just are sort of captivated by the potential returns that they can make. I think a lot of times they sort of back themselves into corners by, you know, sometimes hedge funds will have a good couple years and then a lot of money blows in. and that becomes a lot harder to manage. And there's just not a lot of good places. So a strategy that might have worked well for $100 million,

Starting point is 00:47:13 not so well with $2, $3 billion. And they start kind of looking around for places to juice the returns. They see some interesting derivative strategies that are attractive and are being pitched by Wall Street. They get into those. They start selling a lot of options to Universal to get those nice day-to-day returns. So, you know, I don't know if it's effective with hedge funds, as Nassim says, but I certainly think with banks, when you have systemic risk and the too big to fail issue,

Starting point is 00:47:42 it's certainly something worth exploring is some kind of either a clawback mandated in, you know, banks charter that if the bank fails, the top managers will give up X percent of their salaries from the previous five years or something like that. To my understanding, when looking at Universe's strategy, they kind of take the approach that these Black Swan events are totally unpredictable. We shouldn't try and predict when or what year this is going to happen. I think if someone hears about the story of the universe and making three or four thousand percent throughout the COVID crisis, they think, oh, they just like, you know, bet big on markets just totally collapsing and they did it at the perfect time.

Starting point is 00:48:25 So I'm curious what your thoughts are on, you know, how predictable these sort of things are because I know you tell the story of Taleb, he saw a lot of the warning side. of COVID-19 in January 2020. And he was kind of sounding the alarm bells trying to, you know, wake people up to this. And then Bill Ackman saw the similar thing. So I'm curious what your thoughts are on, you know, are they scaling up some of their bets when they, you know,

Starting point is 00:48:50 see a lot more risk? And where they're at in terms of trying to predict these sort of tail risk events. Yeah, Spitznagle would say that he never speculates. So there have been, you know, I mentioned Aaron Brown earlier. Another thing he told me was that when he looks at the stress, strategy, he doesn't see a way that it could perform as well as it does without dialing up that risk. You know, Mark says Aaron doesn't understand the strategy. How could he? They, it's, they're a black box in a way. Like, you know, we don't really know exactly what they're doing.

Starting point is 00:49:22 We just know what the returns are, which are quite phenomenal. But yeah, he denies that. He denies that they dial up, you know, try to make the bet bigger when they see something looming on the horizon. because their basic perspective is you just can't predict it. There's no telling when it's going to hit. If you keep doing that, you're going to lose money for your clients over time. And he sees that as a losing strategy. It's also hard to imagine a more aggressive strategy than Universal. You know, they're betting on a 20% decline in the S&P in a month.

Starting point is 00:49:55 They could say, okay, let's bet on a 30% decline. How much is that going to really increase the returns? you know, they might get some cheaper options. I mean, they're already dirt cheap. It might get a little bit more upside. So when I think about it, it's hard for me to really, they probably could do it, but it's hard me to think of a more aggressive, explosive upside strategy when they're already employing. I mean, who knows.

Starting point is 00:50:19 Mark says they don't do it. I believe what he says. There are others who, you know, like Ackman, who try to take advantage to the situations. They're, you know, it's some ways that like a gut trade, like they, just feel something's going to happen and now's a good time to trade. And that's what, that's what Ackman does, right? I mean, he's also a very good investor in companies. He understands, you know, what companies are good or bad. He, again, like many others, sort of models himself on Warren Buffett. So he's looking for value. But he also makes these big bets. He did the same

Starting point is 00:50:51 thing in the global financial crisis or he bet against some companies that are exposed to the housing market. But there have been other times in these, you know, we don't even hear about them where he's probably made similar bets and lost all his money. And that's what happens with these trades is if the big event doesn't happen, you make no money. You lose your entire bet. With the 2020 COVID bet, it seemed like a risk worth taking. You know, when you look at it in retrospective, I think it was $20 to $30 million that he spent on these derivative contracts that ended up giving a return of more than $2 billion. So yeah, that seems like a, you know, pretty good trade to make. Not a lot of people did it, though. I'm also curious, just because Teleb is just such a student of wide-ranging subjects

Starting point is 00:51:35 that are going on in the world. Have you talked to Teleb about what are some of the things he's seeing in the world today that he thinks is a risk that is just way overlooked by people? One that comes to mind that you talk about in your book is climate change. I'm curious if maybe Teleb see something else outside of that, too. I asked him about AI recently. And, you know, I obviously everybody's talking about it and people within the AI community are kind of freaked out. I came across the studies. It was a survey of AI programmers, I think from 2022 or 2021. And one of the questions was, what is the risk that AI could lead to the extinction of the human race?

Starting point is 00:52:19 And 10% of those surveyed said that was a risk, which seems like a really high number. But Nassim said he is not that concerned about it. AI. I haven't talked to him in depth about it, but he says it has local benefits. And to him, that's a code word for not systemic, that it might have little areas where it causes some harm, but doesn't spread throughout the system. And that's always something that he's, you know, looking for in terms of a systemic risk that he's worried about. So one, one area that he's expressed a lot of concern about over the years is GMOs, which now. medically modified organisms. And he and some others wrote a paper about that seven or eight years

Starting point is 00:53:06 ago called the precautionary principle. And this is something I delve into the book about that paper. It's an interesting analysis because they sort of use this GMO issue as a way to create a model for looking at potential systemic risk. So it's got to be something that is interconnected with other systems, food systems, obviously, with GMOs, something that can spread rapidly, something that has global effect, global impact. So those are the kinds of things that he's looking for that he would apply the precautionary principle to. And the precautionary principle is not, he did not make that up. It's been around for decades widely applied in Europe, but not so much in the U.S. And the idea behind it is that if something

Starting point is 00:53:57 does pose potential systemic risk to the human race, the people proposing that we do this thing have to prove that it doesn't have that risk. So the onus is on the people doing it, and in this case it would be on the GMO community. They are widely dismissive of such concerns. It's an interesting debate. I just presented as, you know, they outlined it in the paper. And I know the GMO people are very angry about it. You say the, you know, the burden of proof relies on those that are presenting these various ideas. And whatever the idea is, it almost seems like an impossible task to prove that, you know, it's not going to have just a total systemic issue. Yeah. It's a very daunting barrier. So, you know, I guess that if these risks are real,

Starting point is 00:54:45 then I can see why that would be something that. So in Europe, there are regulations against things that are seen as potentially systemically risky. GMOs are a lot less widely used in Europe. Even China didn't allow GMOs in their food system. But plenty of others in America have been very open to GMOs. And it's worth thinking about, I can't, I'm, you know, I'm not a genetic biologist or a molecular biologist. And that's, you know, it's an interesting thing because they address that issue in their paper in the precautionary principle is that experts will say, well, you're not an expert, so you don't get an opinion on this. And they say, well, we're not experts in the specific thing that you're doing, but we are experts in risk and complexity and potential systemic breakdown and ruin

Starting point is 00:55:38 problems for the human race. That's what we know. And what you're doing has some of these properties, and we think that you should consider it. And the GMO people will say, well, you're going to condemn millions of people, it's a death and starvation if we don't pursue these GMOs. It's debatable because when you look at real issues of starvation and hunger around the world, it's not the production of food. That's the problem. It's the distribution of the food. That's the problem.

Starting point is 00:56:04 There's plenty of food being grown. You have war zones, conflict areas, becomes very hard to get food to these people. I mean, China has a huge overproduction of food. that if it was distributed, it would solve the world's hunger problem. So anyway, it's a debate. I'd never really had a strong view on GMOs until I, you know, and I read this paper. I don't consider myself able to solve that particular conundrum. I see upsides and downsides and downside.

Starting point is 00:56:35 I also think that, you know, as I say in the book, I think the GMO genie is out of the bottle already. So we're rolling the dice on that one and see how it goes. Hopefully it's not as bad as Televen as co-authors say. pivoting to talk more about the systemic risks in the financial system, I think back to the great financial crisis, you know, total calamity and chaos struck. And then the Federal Reserve came to save the day, bail out the banks, and continue to provide liquidity to the system for the years after that. So I'm curious if Teleb and Spitznagle are even more excited about their strategy today now that, you know, the Fed has really, you know, provided so much liquidity to the financial

Starting point is 00:57:15 system and now interstraints have cranked up putting a lot of pressure on the system. So I'm curious what maybe their general thoughts are on the strategy today. Spithnagle and Taleb have both been predicting a complete systemic collapse in the financial system for decades. And we came very close in 2008 and 2009. And yeah, we were bailed out by Congress and Fed. So their view was very, very extreme view, my opinion, was no bailouts, let the banks fail if you can stop the bleeding now, but the patient is still sick and we'll just be sick until, you know, we face the reckoning and it's just the longer we wait, the worse it's going to get. I totally disagree that the government shouldn't have done what they did back then because, I mean, we were looking at

Starting point is 00:58:05 general electric failing. We were looking at the entire economy collapsing and the hundreds of millions of people being put out of work around the world. So I think that, you know, what was done was smart and necessary. I also think that the perpetrators were totally left off the hook. And these were people who were easily found, like, you know, people who were running some of these big housing companies, people in the banks that were trading, you know, doing these strategies that lost billions and their managers either were willingly or just oblivious. There should have been, And I agree with Telev. He had a debate with Larry Summers in 2014 or 2015 at a conference.

Starting point is 00:58:48 And Larry Summers was one of the architects of the bailout, the Obama administration. And he was defending it. He was saying, you know, we've improved capital standards for the banks. You know, they're safer now. And Telev was like, yeah, but, you know, the problem is still there. And Summers is like, well, what are you for? And Telev says, I'm for punishment. So I agree with them on some of those.

Starting point is 00:59:09 things, it's a very harsh view to say, just let it all collapse. And that partly comes from, they have a very negative view of intervention of governments, libertarian views, especially Mark. So they kind of see anything that government does is just going to make things worse. You know, so it's created this system where the financial markets are just sort of floating on all this free money. It can't last. The natural order is eventually going to impose itself and no matter what the Fed is going to try to do, which is going to roll right over it. So he's expecting, and he's recently written, that the system is sitting on a time bomb that's going to explode. He won't predict when because he doesn't predict timing of things. He can keep

Starting point is 00:59:57 going for years, but he does expect it to blow up catastrophically, and that'll be good for universes. I think they talk about one of their main risks is that the banks aren't around to pay up when their trades are successful, that the system just completely collapses, which should just be bad for everybody. But that's, we're talking about like back to caveman days. That is another thought that comes to my mind when so many families and so many people are suffering in a drawdown and in a downturn and people are losing their jobs and such and massive employment. If authorities see a company, you know, making billions upon billions in face of this calamity, you know, part of me thinks the rules are just going to change and somehow,

Starting point is 01:00:39 one way or another, they're just not going to get the payout that they thought they were going to get. I guess you never know. I mean, one thing you got to remember with Universal is they're protecting investors against these calamitous events, including pension funds. So it's not just like they're pirates that are, you know, raping and pillaging and making money on other people's misery. They're actually helping their clients, which includes pensioners and retirees. That said, you never know what regulators are going to do. I've never heard of any threat because they're just, you know, they're trading on open markets. It's very transparent stuff. I would say if you look back at what happened in the global financial crisis, there were firms that created brand new trading strategies

Starting point is 01:01:25 and derivatives that were expressly designed to benefit from a blowup in the housing market. It was entirely new. You know, several of the big money center banks created these things, these swaps. And if those hadn't existed, the disaster wouldn't have been as bad. But at the same time, it's hard to say they weren't really doing anything technically illegal. They were just creating these instruments that other parties happily sold them. And they made a lot of money on it. But you never know. I mean, regulators can be unpredictable.

Starting point is 01:01:59 That's for sure. Well, Scott, this is a really fun conversation. I loved reading through your book, The Chaos Kings, newly published around the time. that this episode is going to be going out. So thank you so much for joining me. Before we close it out here, I wanted to give you the opportunity to give a handoff to whatever you'd like and where people can find the book. Yeah, sure. They can find it on Amazon. I have a website, Scott Pattersonbooks.com, and can find me on Twitter at Patterson Scott. Awesome. Thank you so much again, Scott. I really appreciate it. Thanks a lot, Clay.

Starting point is 01:02:35 Thank you for listening to TIP. Make sure to subscribe to millennial investing by the Investors Podcast Network and learn how to achieve financial independence. To access our show notes, transcripts or courses, go to theinvestorspodcast.com. This show is for entertainment purposes only. Before making any decision consult a professional, this show is copyrighted by the Investors Podcast Network. Written permission must be granted before syndication or rebroadcasting.

Starting point is 01:03:05 Thank you.

We Study Billionaires - The Investor’s Podcast Network - TIP558: How Ackman & Taleb Profited Billions During Market Crashes w/ Scott Patterson

There aren't comments yet for this episode. Click on any sentence in the transcript to leave a comment.