(B) The stock market in 2020 has been one of the weirdest ones that I ever witnessed, as it was insanely disconnected from the economy. While the economy shrunk due to the Covid-19 pandemic, we had a bull market due to extraordinary ingestion of liquidity and zero interest rates.

As shown in the chart below, the stock market went to three phases in 2020:

• January 1st to February 18th – a period of denial of the pandemic
• February 19th to March 23rd – the crash with the S&P 500 plummeted 34%, a drop akin to the 1929 stock market crash
• March 23rd to December 31st – a bull market triggered by new aggressive monetary – zero interest rates – and fiscal policies similar to the ones implemented during the 2008-2009 financial crisis – starting with the US Federal Reserve announcing an aggressive program to establish new credit facilities to employers, consumers, and businesses, and the $2.9 trillion Coronavirus Aid Relief and Economic Security (CARES) Act

According to Professor Robert Shiller in “understanding the pandemic stockmarket“, investors psychology is the only way to explain that inverse correlation that can occur between the stock market and the economy:

“The more economic fundamentals and market outcomes diverge, the deeper the mystery becomes, until one considers possible explanations based on crowd psychology, the virality of ideas, and the dynamics of narrative epidemics. After all, stockmarket movements are driven largely by investors’ assessments of other investors’ evolving reaction to the news, rather than the news itself.”

In that volatile environment, some hedge funds did well as reported by the Wall Street journal: “Covid-19 Caused Chaos for Investors in 2020. These Hedge Funds Earned Billions” by investing in technology companies in particular cloud providers (AMZN…), and Covid 19 stay-at-home thriving stocks (ZM, PTON…).

But the best hedge fund return in 2020 was delivered by Universa Investments: 4,144% in Q1 2020! Funded by Mark Spitznagel, and advised by Nassim Taleb, Universa’s fund strategy implements a “black swan protection protocol” or “tail hedging”. The fund can be viewed as an insurance against negative Black Swan events. It combines various types of options but very simply said, it invests in 2-month puts that are 30% out of the money. Most of the time, 95 out of 100 trades, the fund loses a little bit of money but when a negative Black Swan event occurs, the fund makes an incredible amount of money proportional to the disruption of the Black Swan event.

The fund recommends its clients to invest 3.3% of their portfolio into Universa, and the rest of their portfolio in the S&P 500.

As I previously wrote in “Investing Like Nassim Taleb“, the long-term performance of a portfolio is not smooth and steady over time but largely determined by a few significant market moves generated by Black Swans.

The occurrence of a Black Swan can trigger market bubbles (positive Black Swans) or market crashes (negative Black Swans) and leads to large creations or destructions of wealth in a portfolio.

According to Mr. Taleb’s someone needs to be both hyper-conservative and hyper-aggressive to be successful in her or his investment strategy.

Hyper-conservative by investing 85 to 90% of her or his portfolio in Treasury bills to avoid any market risks, or if you can take more risks investing in the S&P 500 (as suggested by Universa), or a more diversified portfolio of assets such “Investing Like David Swensen“.

Hyper-aggressive by investing the remaining 10 to 15% of the portfolio:

• In positive Black Swans such as new business ventures where the downside is limited (the worst case scenario is that all the money is lost) but where the upside can be very significant (acquisition or IPO)
• While protecting the portfolio from negative Black Swans by (assuming you know how to do it!) implementing a tail hedging investment strategy as does Universa.

References

“Here are the top performing stocks in the S&P 500 for 2020” from CNBC.

To deep dive into Professor Shiller’s narrative economics:

To deep dive in the basics of Black Swan investing:

• Black Swans Gray Swans and White Swans, A Silicon Valley Insider

• The Risk of a Black Swan in Your Portfolio, A Silicon Valley Insider

• Investing Like Nassim Taleb, A Silicon Valley Insider

• Nassim Taleb ‘s lecture at Stanford University: How Things Gain from Disorder?

To deep dive into Universa’s tail hedging:

• Mark Spitznagel’s book: The Dao of Capital: Austrian Investing in a Distorted World – here is an excellent review of that book

• The history of Universa Investments:

• Universa’s interim decennial letter – April 7, 2020
• Mark Spitznagel interviewed on CNBC:

Note: The picture above is a well cooked sea urchin.

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