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Talebs Black Swan Investors Post Gains as Markets Take Dive

Date: Wednesday, October 15, 2008
Author: Stephanie Baker, Bloomberg.com

Investors advised by ``Black Swan'' author Nassim Taleb have gained 50 percent or more this year as his strategies for navigating big swings in share prices paid off amid the worst stock market in seven decades.

Universa Investments LP, the Santa Monica, California-based firm where Taleb is an adviser, has about $1 billion in accounts managed to hedge clients against big moves in financial markets. Returns for the year through Oct. 10 ranged as high as 110 percent, according to investor documents. The Standard & Poor's 500 Index lost 39 percent in the same period.

``I am very sad to be vindicated,'' Taleb said today in an interview in London. ``I don't care about the money. We're proud we protected our investors.''

Taleb's book argues that history is littered with high- impact rare events known in quantitative finance as ``fat tails.'' As the founder of New York-based Empirica LLC, a hedge- fund firm he ran for six years before closing it in 2004, Taleb built a strategy based on options trading to bullet-proof investors from market blowups while profiting from big rallies.

Mark Spitznagel, Taleb's former trading partner, opened Universa last year using some of the same strategies they'd run since 1999. Pallop Angsupun manages the Black Swan Protection Protocol for clients and is overseen by Taleb and Spitznagel, Universa's chief investment officer.

``The Black Swan Protection Protocol is designed to break even 90 to 95 percent of the time,'' Spitznagel said. ``We happen to be in that other 5 to 10 percent environment.''

Options Strategy

The S&P 500 dropped 18 percent last week, its worst week since 1933, on concern that the credit crunch would cripple the financial system and trigger a global recession.

``We got a lot of giggles when we said we're targeting 20 percent moves,'' Spitznagel said. He and Taleb declined to confirm the investment returns listed in the documents, which were reviewed by Bloomberg News.

Taleb's strategy is based on buying out-of-the-money options -- puts and calls whose strike price is either lower or higher than the market price of the underlying security. A put option gives the buyer the right, though not the obligation, to sell a specific quantity of a particular security by a set date. A call option gives the right to buy a security.

The Black Swan Protection Protocol bought puts and calls on a portfolio of stocks and S&P 500 Index futures, along with some European shares. The Black Swan Protocol doesn't rely on commodities, currencies or insurance on bonds known as credit default swaps, Taleb said.

``We refused to touch credit default swaps,'' Taleb said. ``It would be like buying insurance on the Titanic from someone on the Titanic.''

White Swan

The Black Swan strategies are designed to limit losses to a few percentage points. Some investors did better than others depending on when they decided to lock in profits, Taleb said. The returns have enabled Universa to line up more money from investors in the next month, Taleb said.

As a trader turned philosopher, Taleb has railed against Wall Street risk managers who attempt to predict market movements. Even so, Taleb said he saw the banking crisis coming.

``The financial ecology is swelling into gigantic, incestuous, bureaucratic banks -- when one fails, they all fall,'' Taleb wrote in ``The Black Swan: The Impact of the Highly Improbable,'' which was published in 2007. ``The government-sponsored institution Fannie Mae, when I look at its risks, seems to be sitting on a barrel of dynamite, vulnerable to the slightest hiccup.''

Taleb said the current crisis is a ``White Swan'', not a Black Swan, because it was something bound to happen.

``I was expecting the crisis, I was worried about it,'' Taleb said. ``I put my neck and money on the line seeking protection from it.''

Taleb is angry that Wall Street is continuing to use traditional tools such as value at risk, which banks use to decide how much to wager in the markets.

``We would like society to lock up quantitative risk managers before they cause more damage,'' Taleb said.

To contact the reporter on this story: Stephanie Baker in London at stebaker@bloomberg.net