Universa’s Mark Spitznagel on Making Money While Markets Crash
Mark Spitznagel, the founder of hedge fund Universa Investments, is one of the most interesting figures in the world of hedge funds. After starting his career as a futures trader in Chicago, Spitznagel would go on to partner with Nassim Taleb, of Black Swan fame, to start a fund called Empirica Capital in 1999. Spitznagel founded Universa in 2007 on his own with the purpose of starting a fund that would perform capably during periods of market stability but vastly outperform during financial crises. In 2007-2008, Universa posted returns of over 100 percent, and during a short-lived market rout in August 2015, Universa made $1 billion in a single week. Worth spoke to Spitznagel about his investment strategy, why risk mitigation actually allows investors to take risks, and whether COVID-19 is the beginning of our next great financial crisis.
Q: What’s the premise of Universa’s investment strategy?
A: The most basic way to describe our strategy is that we are insurance against systematic stock market crashes and crises in general. I could elaborate by describing it as high deductible insurance that kicks in for very large moves. It’s trying to make high returns through risk mitigation. Gold should immediately come to mind, as should bonds, and of course that’s why people invest in hedge funds.
You’ve also argued that Universa actually allows clients to take on risks and worry about them less.
Yes. Universa is also there so that my clients can maintain and take on exposures to the markets in general. You hedge risks so that you can take risks. The best way to think about that is the simple insurance that people can buy on their home. If there were no such things as homeowners insurance, a lot of people wouldn’t be able to buy their home, because it’s just too risky. Which is why insurance is required when you buy a home.
So in that sense, Universa is both defensive and offensive. It prevents bad contingencies from happening.
But you also argue that, in times of financial crisis, the returns from a Universa investment are far, far greater than the returns of having hedged with gold or bonds.
We’re like bonds and gold only in the sense that we are a risk mitigation strategy and therefore you should compare Universa to other risk mitigation strategies. But we go about it in very, very different ways. What’s unique about Universa is that we have what I call a very explosive downside payoff. We deliver extreme crash bang for the buck, and that’s what sets us apart from virtually any other risk mitigation strategy. We’re like gold on steroids.
Be more specific—what might a gold upside be, and what would a Universa return be under the same market conditions?
Typically, one would have experienced gold making something in the order of magnitude of 30 percent in a stock market crash, with a huge range about that—sometimes it’s overperformed that number, and sometimes it’s underperformed. But that’s your mean expectation based on history. Whereas at Universa, we’re talking 100 to 1.
The obvious question is, how do you do that? Because it sounds too good to be true.
People like to complain that I’m always tight-lipped about this—well, why the hell should I talk about it? You’re damn right I won’t talk about it. But I will say that there is no black box here. I give full positional transparency to my clients. There’s nothing fishy going on, there’s no wink-wink, trust me. My clients know exactly where their money is. But my non-clients have no idea what I’m going to do, and I want to keep it that way.
Having said that, I would never want some retail investor or even a professional to try these [strategies]—they will rue the day that they did that. This is a dangerous place for amateurs and professionals alike to play. So I’m doing people a favor too when I’m not telling them [what we do].
How do you answer folks who say, OK, but in between the crash of the Great Recession and what’s happening now, the stock market has been on a roll—how does Universa do then?
We’ve had one crash since Universa started in ’07, and our record is out there. [The Wall Street Journal reported in 2018 that a 3.3 percent allocation in Universa produced a 12.3 percent annual return over the preceding decade.] But it’s not a binary thing. When you have these middle-of-the-road crashes—sometimes we call them shoulder moves—we tend to do quite well as well. It’s not all or nothing.
What’s the formula there—that you do extremely well in a crash, but basically fine even if there isn’t a crash?
The whole sort of structure of the position that we [take] is to lose very small amounts when there’s no crash and make a whole lot when there is one. That is our objective.
If you’re going to innovate, you can’t run with the sheep.
But you also work on the theory that the fund will do well even if there are no financial crashes.
The way we structure our risk mitigation strategy, if there’s never a crash again, we will remain the optimal risk mitigation strategy going forward. And that is because we’re so efficient, this extreme asymmetry, this extreme crash bang for the buck. Last year, Universa’s risk-mitigated strategies outperformed all the other risk mitigation strategies that I know of. And that applies to the last five years.
The idea that you can make money off risk mitigation in years the markets are doing well runs contrary to what most people think about the nature of risk mitigation.
Risk mitigation, as we all have come to understand it, is something that is costly. We lower our risks and it costs us money, but hey—we’re able to sleep at night. But your run-of-the mill risk mitigation –gold, bonds, hedge funds—have all cost people who’ve invested in them money.
I argue that risk mitigation should not make you poorer. It should move the needle on raising the returns of your portfolio.
You’re known for having done very well in the Great Recession. Will coronavirus lead the world into its next global recession?
Is this the crash? I don’t know. I do not know. But I don’t need to understand everything about the world—I need to understand very little about the world. I surely don’t need to understand pandemics, geopolitics, how risky the banking system is. It’s not about claiming to have figured it all out and then putting out this brilliant strategy that makes money—it just looks like that after the fact. It’s really about payoffs.
Given that markets have been hurtling downward, have people not yet invested in Universa missed their moment?
It’s not too late, and certainly people are getting more interested now. Because another great edge that we have is our ability to insulate ourselves from really bad pricing. It’s really a mistake for investors to think about what I do as a tactical allocation. If you had an edge in timing, if you had some brilliant macroeconomic forecasting crystal ball, you could say I’m going to invest in Universa right before a crash. But trust me, there is nobody walking the earth who has that edge. There are people who get lucky. So treating Universa as a tactical hedge—there’s no point. You miss it.
Mark, when you first attracted attention for having delivered outsized returns during the financial crisis, you were spoken of as a “doomsday investor” who feasted on bad news. Now that Universa has been around for a while, do you get the sense that perceptions of you have changed?
I don’t know. I suspect that there are plenty of people who still think of me as like a Bond villain who loves it when there’s misery. But they shouldn’t. If you’re in the security business, you don’t want your clients to get attacked. I’m in the contingency planning business.
But you’re still seen as something of a rebel, it seems to me.
If you’re going to innovate, you can’t run with the sheep.