Black Swans & Tall Risk Protections

The only constant in the world is change and that phenomenon is not slowing down any time soon. The world is full of more unknown than known variables, which makes preparing for certain events or occurrences very difficult. How can you know what you do not know? Hindsight has the benefit, rightly or wrongly, of 20/20 vision. Generally speaking, we liked to rationalize things – especially things we do not and cannot understand. We want to predict the forecast, attribute bad behavior to a single significant event in life, win big on sports bets and we long to beat the markets. It is of note, however, that we need to accept the unpredictable nature of, well, nature. There are rare and unpredictable events that impact the world on virtually every level much more so than small more frequent events.

Finance professor and former Wall Street trader Nassim Nicholas Taleb coined the term ‘black swan’ to describe these rare events. Black swan events have a rippling and disruptive effect; think of the rise of the internet, mobile phones, September 11th attacks and the recent flood in Calgary. Taleb argued that people develop a “collective blindness” to these events because they are non-computational; there is no way to predict the probability of them.

We want to know the future and we want to predict the markets. There are certain models and formulas and computational paradigms that might allow for a level of predictability, but it is simply not possible to prepare for a black swan event. Who knows when they will hit and how long they will last.

As it relates to investing…

There are so many things to consider when you want to invest your money, like how you can protect your wealth, make money, where and how you will invest it. These are all things that we can quantify for the most part, but what about the unknowns? There are many variables that we cannot account for  - no matter how sophisticated the model.

In order to prepare for these black swan events, we believe it is key to have non-correlated assets managed with a rules-based approach that will help to protect your wealth when the unpredictable happens. We all seemed to learn the hard way ins 2008/09 that there are very few meaningful ways to diversify. Our cards are on the table, we have a slight commodity tilt and we see the advantages of this every day. The significant role that commodities play as a managed future is proven as it was “the sole hedge fund category with positive performance in 2008/9″ according to a white paper published by the FTSE.

Why? Tail risk protection.

Non-correlated assets that are managed in such a way do not succumb to the CNBC reporters or the BNN clips that spark or put water on investor fires. These approaches do not allow outside factors to solely influence trades and also offer tail risk protection, which is where these black swan events hit hard. As we’ve seen in previous articles, the great rotation of assets appears to be coming to an end for this cycle, which could signal a big shift in market behavior. Market gyration influences several portfolios, most often negatively.

“Risk lies in the future, not the past” (Financial Post).

There are many things we can predict, but there are many more we cannot. Be wary that the accuracy of these predictions can quickly be turned on their head; so many factors can render strategies null and void. We cannot rely on models to dictate our lives, but there is a purpose to them. Don’t let hindsight biases create irrational conclusions – how could you have known?

Accept that there is uncertainty all around – we know a lot, but not everything.