The Big Picture for the Week of June 19, 2011

Hat tip to Mebane Faber for finding this article at Forbes that among other things notes that Universa Investments (the fund that Nassim Taleb advises in some capacity) is mulling a black swan ETF. This evokes curiosity, amusement and befuddlement all at the same time.

Curiosity because the 90% in foreign t-bills and going berserk (my word not his) with the other 10% appeals on some level, amusement because of the jokes about this being a bottom and befuddlement as it would seem that Taleb would benefit from an industry that he probably thinks very little of.

While it is too soon to know if this fund will ever start trading, just as we talked the other day about a dividend tranche to a portfolio, maybe a Taleb Tranche would make sense too? The first time I heard Taleb was on the Connie Mack show on PBS and back then he expressed his concept as 85-90% in t-bills from around the world and then speculate very aggressively with the rest. Universa seems to have taken this idea and tweaked it to be t-bill-like with most of the portfolio (not sure if that means t-bills from around the world or not) and then betting on very extreme outcomes (like the end of the world) with the rest with the expectation that betting on extreme outcomes will lose money the vast majority of the time but when it pays off it will be huge.

Speculation in the context of his original idea is far more interesting than continually buying puts that are 400 points out of the money (I'm sure that is a gross oversimplification of what they do). Speculations like smaller volatile stocks that have some basis for going up in value makes more sense to me. Remember Taleb was talking about 10-15% of a portfolio and I am talking about 10-15% of a slice of a portfolio. This might mean buying something like the Global X Fertilizer/Potash ETF (SOIL), trading options on stocks or buying something like South Gobi Resources (SGQRF).

The t-bills from around the world effect is probably a more interesting thing to ponder. In actually going with t-bills from all over it is an attempt not only avoid volatility but remove currency swings. If we are talking about enough money to own ten currencies then in theory currencies with different attributes could be chosen such that when some go up some should go down. In practice it might not work out as well as for now seemingly every currency goes down against the USD in times of crisis. Perhaps a healthy dose of US t-bills could sterilize this.

In terms of creating the effect there are countless combos of exposure that can be built using ETPs and also traditional mutual funds. Things like hedge fund replicators, currency funds, inflation protected securities funds (recently Shares launched GTIP and ITIP which provide foreign exposure), absolute return products and probably a couple of others that are not coming to mind. In terms of different segments targeting similar results I would prefer spreading it out in case of some one-off event that is not reasonably analyzed. If something crazy happens in the world of merger arbitrage and that is all you own because how well the funds always seem to work then you have a real problem.

Part of why this is interesting to me is that I believe US capital (maybe that should be Capitol) markets are extremely distorted. For fixed income the rates and various "normal" relationships that exist are out of whack and on the equity side I think we have more years of not making any real progress. To repeat from past posts the answer for equities, if the above theory is correct, is more foreign exposure. Fixed income is a little more complicated and perhaps the above could be part of the solution. Right now you need to go out pretty far to get 3% in high grade debt but in the big picture 3% is not all that hot. If some combo of the above can deliver a 3% total return with similar volatility characteristics as fixed income then for people not yet taking income from their portfolio this could be a better way to go for the time being. Or at least with a portion of fixed income.

One other thing to note is that if the US capital markets remain out of sorts for an extended period that doesn't mean perpetual crisis to the point of markets not functioning. If the SPX is at 1115 on December 31, 2019 (that is the level it was at on December 31, 2009) that does not have to mean markets stopped working, I mean literally, in fact ceasing up again is a low probability.