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One on one: Nassim Nicholas Taleb

More from our exclusive interview with Black Swan author.

March 11, 2015

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story_images_black swan_sizeNassim Taleb divides people into two camps: those who will fall apart during times of crisis and those who’ll be picking up the pieces—and profiting in the process.

The statistician, ex-options trader and author of some of the most influential finance books of the last 20 years, calls the latter group “antifragile”: robust organizations with the ability to flow through crises without cracking under the pressure. “The world is more random than we think. You are going to make more mistakes than you ever think you are going to make, and you don’t know where or when,” explains Taleb, author of The Black Swan, Fooled By Randomness, and Antifragile: Things That Gain From Disorder. “But it’s not bad news at all if your systems are set up to gain from an increase in disorder over time.“

The roots of his theory stem not just from mathematics but also from his career on the derivatives desk. “Everything I learned in options uses the same mathematics as fragility,” he says. “When you wake up in the morning, you need to be protected from mistakes in order to survive. You also need to be positioned in a way that if you lose, you lose small. And if you make money, you make it big—at least bigger than what you would lose.”

But don’t get “too fancy” about avoiding mistakes. Instead, ensure that “should a problem happen, you are either not harmed by it or benefit greatly from it. That is the whole idea of antifragile.”

For pension funds focused on avoiding volatility, this approach has implications for risk management as well as portfolio construction. Take the practice of portfolio stress testing, which is gaining a foothold in the pension space. Can this practice help make organizations more antifragile? A timely question: at the time of this interview, Taleb was getting ready to present his findings on stress testing to the European Central Bank.

“The way banks are doing their stress testing isn’t sophisticated enough to detect problems—as a matter of fact, it works backwards,” says Taleb. “We have to be careful about what we call stress testing. What we’ve introduced is not stress testing. Rather, it’s a way of figuring out if you’re exposed to tail events in an accelerating or decelerating way. In other words, there’s a way to detect if a company has more positive or negative exposure to tail events that’s much better than a stress test.”

In simplified terms, “it’s much easier to measure how things react to random events than to forecast random events. We know, for example, that if you have a lot of debt, you’re not going to do as well if there’s a crisis. However, someone who is in the opposite position— namely, with cash in the bank—will do a lot better when there’s a crisis. That is when fortunes are made.”

So, organizations with dry powder benefit in tough times. And therein lies a valuable piece of information for creating an investment portfolio: how a company weathers a crisis is a marker of its long-term viability. “Try to invest in companies that have had some trouble in their past and have survived it,” Taleb advises. “You have information about how they will fare.”

Remember the Tech Wreck? “Silicon Valley collapsed and came back and learned a phenomenal lesson. Hopefully, they will have another crisis to learn from because it will teach them to stop being arrogant. They start getting arrogant every 15 years,” says Taleb. “Your portfolio should be positioned to see more of the upside of random events than the downside.”

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