Investing Philosophy Nassim Taleb/Mark Spitznagel - Balancing Portfolio with Tail Hedge

Investing Philosophy Nassim Taleb/Mark Spitznagel - Balancing Portfolio with Tail Hedge

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00:05
the returns vs. risk battle is a frontline of investing we all want higher returns with lower risk but of course the two are seen as a trade off traditional asset allocation deals with this by striking a balance between risky and less risky assets typically between stocks and bonds think of your portfolio as a pie we can slice it in two different pieces by these different allocations the size of each piece representing its relative size in your portfolio an allocation of 60% to
00:36
stocks and 40% to bonds is a pretty standard simple pie in the investment world the idea behind this typical weighting as you can see here is that these two slices stocks and bonds balance each other in terms of their risks as they typically go up and down in opposite directions or at least don't often collapse together so over long periods of time and over many environments this combination should do pretty well hopefully better than average some take this balancing act even further adding more slices for
01:07
credit spreads real estate emerging markets and so on and many smart people with all kinds of complicated formulas and forecasts and a lot of capital work to fine-tune this intricate balance but simple or complex the point here is the same the problem is all this fine-tuning doesn't always work out so well all of these slices at times can get distorted and manipulated into bubbles as central banks compress interest rates and lure investors into ever riskier assets there's immense pressure to add to the slices with the highest yield and
01:38
best performance and we find ourselves chasing the most immediately gratifying as well as the most expensive and riskiest assets and also Talisa coming to these cereal bubbles we even find ourselves here today or not owning enough high returning assets like stocks feels foolish like missing an opportunity to a very very risky one so what do you do there must be a better way than this to allocate capital and manage this presumed trade-off between returns and risk well there is what if you could take a tiny sliver of a slice
02:09
of your portfolio pie and invested in something that does even better when the bigger slice stocks goes down notice how profits in this tiny slice essentially cancel out the losses in the stocks this loss cancellation allows you to actually take more risk in stocks and of course being such a tiny slice it couldn't hurt you much when stocks rise especially compared to what you gain with your larger stock position no matter how far that sliver goes down this sliver this acts very much like an insurance hedge hence the name tail
02:40
insurance or tail hedge by allocating say just 1% of your portfolio to the tail hedge sliver as universe' does by owning put options you could go from a 60/40 stocks bonds mix to a much greater stock allocation and yet your portfolio's total risk would go down the key here is the tiniest of that sliver relative to how much can make when stocks go down or in financial parlance the asymmetry of that position this means that when stocks go up it only costs a very small amount on its own
03:12
relative to what it can make when stocks go down this asymmetry is challenging to conventional asset allocators as it just doesn't fit in with their conventional models it even creates what looks like a paradox how can higher returns possibly come from lower risk whatever happened to the trade-off the real challenge here as well as the real opportunity why is it a misperception when looked at in isolation like this this tiny slice will look like a disadvantage when stock markets rally however as we saw when looked at holistically within the
03:44
context of an entire portfolio like this it becomes clear what a huge advantage in transformation it can create the tail hedge allows for a bigger slice of stocks in the investment pie than the 60/40 portfolio because the stocks are protected in a steep sell-off the tail hedge portfolio does indirectly and counter-intuitively beats the 60/40 portfolio as well as most alternative investments and other supposes low-risk things and as you can see here it beats them when stock markets rise and when they fall and importantly after the fall
04:16
when everyone else is selling their stocks notice how the tail hedge has created all this cash or liquidity to use to invest in more cheapen stocks and this is cash you would otherwise have only if you would started with a much smaller stock allocation so you can see how that tiny sliver of a hedge in its own indirect roundabout way in up and down markets can be the driver of consistently higher returns for the entire portfolio investing this way is what I've been doing my whole career and it's precisely what universe' did for clients in the
04:47
2008 crash and in the rally that followed moving from a traditional stock bond balance portfolio to a tail hedge portfolio requires viewing asset allocation and risk in a different way holistically rather than reductively but when looked at in this way there is no trade-off there is no paradox and higher returns really can come with lower risk you

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