How an investor and cheese producer received a yield of 4144% in a market collapse
Libertarian Mark Spitznagel has developed one of the most ingenious strategies in Wall Street history. The financier has been waiting for his finest hour for 12 years, since the last world crisis. It came this year when the Wuhan coronavirus turned into a "black swan" that collapsed the stock market. Since the beginning of the year, the hedge fund of former student Nassim Taleb brought its investors a return of 4144%.
Investor Mark Spitsnagel decided to wait out the coronavirus pandemic at his farm, located on a hilltop near Lake Michigan. The picturesque place resembles one of the works of the American landscape painter Winslow Homer. There, in self-isolation, the founder of the Universa Investments hedge fund relishes his recent success, which can be called one of the most brilliant tactical moves in Wall Street history.
Very soon, 400 newborn alpine goats will appear on the Idyll Farms Spitznagel farm, which, along with the rest of the herd, will graze in meadows with an area of more than 800,000 square meters. m. From the goat's milk on the farm makes a spicy cheese with aromas of herbs and honey. “We have reached the maximum level of vertical integration,” says Spitsnagel with pride. However, raising goats and making cheese is just the hobby of a 49-year-old American investor. In the financial market, he is known as one of the most daring players and an expert on risky transactions.
Universa Investments hedge fund now manages $ 4.3 billion worth of assets. Spitsnagel’s team includes nearly a dozen candidates of sciences, mathematicians and experienced traders. All of them earn money by making transactions that almost always bring small losses and very rarely - space profitability. The Spitsnagel hedge fund is buying up short-term option contracts, which can be called a kind of protection against a sharp surge in volatility or the collapse of stock markets. For Universa Investments to pay off, something completely unpredictable must happen, leading to a sudden recession in the global economy. In normal times, investors from all over the world easily earn money every day by selling short-term options to Spitsnagel and his team (the so-called contract under which the buyer acquires the right to sell the underlying asset to the seller at a fixed price during the term of the option).
But everything changes when every five or ten years a “black swan” appears on the horizon, be it the September 11, 2001 attacks or the beginning of the global coronavirus pandemic, which led to the collapse of the world economy. Thanks to such events, Universa Investments can earn an astronomical amount, which will be more than enough to compensate for all its many losses. All traders who fall on the bait of Spitsnagel find themselves in an insidious trap, from which it is sometimes impossible to get out. Some of them suffer huge losses, while others are completely ruined.
“Many customers rely on the market rebound”
In March 2020, the S&P 500 index fell almost 30% from its maximum. The American market has lost several trillion dollars of capitalization. Anticipating this, Spitsnagel bought put options at a price well below the market. As a result, March was the best month in the history of his hedge fund.
Last month, Universa Investments' underlying fund called Black Swan Protection Protocol brought its investors a return of 3612%. Since the beginning of 2020, the fund's return amounted to 4144%. On April 7, Spitsnagel, from his self-isolation, sent two dozen investors Universa Investments a letter of congratulations, which soon spread all over the world. “Most likely, for all the time that you have been working with us, you have never seen such a return on investment. Congratulations on the fact that you once made such a reasonable tactical decision to invest in Universa Investments, ”Spitsnagel wrote.
Spitsnagel helped build a successful career with the greed of traders who chose easy income over informed risk-taking. To make money quickly and easily, traders readily go for the sale of option contracts, which can ruin them in the event of an unexpected collapse of markets. However, when signing a contract, traders most often think that such an outcome is unlikely. In the end, one of them falls into the trap of Spitsnagel. When stock markets panic due to some unpredictable event, such as a coronavirus, Universa Investments hedge fund in an instant turns from a kind of “charity” into one of the most influential players in the market. Then Spitsnagel satisfies the new momentary requests of traders, due to their panic.
According to Spitsnagel, his hedge fund is buying up options, "which no one has been paying attention to for years." At a turning point, Universa Investments can sell securities that would normally cost quite inexpensively for a rather round amount. “Liquidity is the price of the opportunity to sell an asset as quickly as possible. When buying and selling assets, we are fully aware of this fact, ”says Spitsnagel.
According to Forbes, in March short-term option contracts, which cost less than $ 100 million, brought Universa Investments customers at least $ 3 billion, which they can invest in cheaper shares or leave them under a mattress. The reports that Universa Investments provides to regulators indicate in small print that the assets of the hedge fund are $ 4.3 billion. However, the Universa Investments team actually works with much lower amounts, which range from about 2% to 3% of those $ 4.3 billion. That is why in March we did not hear about the new "trillionaires."
To get such a return, investors paid Universa Investments about 1% of the invested amount as a service fee annually, Forbes found out by examining the above reports. Based on the end of March 2020, the Black Swan Protection Protocol fund since its inception in 2008 has provided Universa Investments customers with an average annual return on investment of 76%. This is an excellent indicator, but if you return to December 31, 2019, you can see that the total yield of the hedge fund at that time was not much higher than that of the S&P 500 stock index for the same period of time. In addition, there are currently “forces of goodness” in the market, for example, the Federal Reserve.
Mark Spitznagel grew up in the small village of Northport in Michigan. His father was a clergyman in a local Protestant church. At 16, Spitsnagel visited the Chicago Board of Trade, where he met a successful trader named Everett Clipp, who was involved in futures trading. It was a fateful meeting. Spitsnagel was fascinated by the "intricate system of interaction in the markets and the synchronous work of traders." Every summer during his school holidays, he came to Chicago to work for Clipp. He carefully studied grain prices and the reporting of agricultural enterprises.
Clipp explained to the impressionable teenager how important it is to put up with the inevitability of small losses. “I used to be able to come to Everett’s office with a pile of papers to present my new report on the grain harvest. Usually he just laughed at me and said that all this is nonsense, ”recalls Spitsnagel. According to the investor, his mentor always emphasized that "the main thing in this business is the ability to put up with losses." Spitznagel saw traders go broke one after another after margin calls. All this was reminiscent of the final scene from the cult film of the 1980s, “Swap places,” which only strengthened the teenager’s belief in Clipp's rightness.
In 1993, Spitsnagel graduated from a private college in the Michigan city of Kalamazoo. At age 22, he bought a seat in the Chicago Board of Trade and began buying and selling futures on treasury bonds and the EUR / USD currency pair. The Chicago Board of Trade, in which chaos has always reigned because of active open trading with shouts, has been the forefront of the development of world capitalism. This enthralled the young libertarian. To this day, on one of the walls in Spitsnagel’s office, his “trading uniform” is hanging in a frame - a “survivor of bloodshed” sea-green jacket and a tie with a portrait of Adam Smith.
The difficult test for Spitsnagel was 1994, when the US Federal Reserve unexpectedly raised interest rates, which led not only to a drop in the treasury bond futures market, but also to the bankruptcy of many traders. “This period definitely had a significant impact on me. I saw how traders, whom I considered heroes, lost everything, ”recalls the investor. He managed to overcome the crisis only thanks to the instructions of the old teacher. Spitsnagel fully accepted the inevitability of minor losses. “If you look like a donkey, then you feel appropriate,” the investor emphasizes.
After some time, Spitsnagel began working in the trading division of a Japanese bank. He witnessed the onset of the 1997 financial crisis in Asia and the 1998 default in Russia, which were one of the reasons for the collapse of the famous hedge fund Long Term Capital Management. The board of directors of the hedge fund included Nobel Prize winners in economics, but even they were not able to prevent the loss of $ 4.6 billion. These events convinced Spitsnagel to develop his own investment strategy and a special approach to managing market risks. He decided that next time he could make money in a panic in the markets. In 1999, Spitsnagel entered the Courant Institute of Mathematical Sciences at New York University, where he studied under the renowned economist and author of the theory of the “black swan” Nassim Taleb. In the same year, they together opened the hedge fund Empirica Capital. Spitsnagel and Taleb relied on maximizing profit from unlikely events that could significantly affect the global economy. After the hedge fund was liquidated in 2005, Spitsnagel worked at Morgan Stanley for a couple of years. In 2008, just a few months before the start of the financial crisis, he founded Universa Investments.
The yield on the hedge fund in 2008 was 115%. Spitznagel spent part of the money earned to buy a mansion in the prestigious Bel Air district with singer Jennifer Lopez. The trader’s house was literally a block from the residence of his idol and former US President Ronald Reagan. Five years later, Spitsnagel wrote The Dao of Capital, a 368-page libertarian economic treatise in which he criticized central banks for allowing a financial crisis. Unlike most investors who play for a fall and try to guess the moment the “bubble” of the economic bubble began, Spitsnagel has a different strategy. Regardless of the circumstances, he incurs non-critical losses every day to collect an arsenal of options and futures that can make him rich if a panic starts on the market.
“If people think that the market is dipping now, then they are fooling themselves. They are simply deceiving themselves! ” - says Spitsnagel. Many may have the impression that he is always dissatisfied with something. However, due to his mathematical view of the world, Spitsnagel even reminds one of the eternal optimist Warren Buffett. Svalbard skillfully traps traders, promising them easy money for short-term option contracts. He himself awaits the onset of the economic crisis and the collapse of the stock market in order to maximize the benefits of the situation. This is similar to Buffett's investment strategy, which has been accumulating a monetary reserve over a long period in order to profitably buy cheaper assets in the fall of the stock market. Spitsnagel notes that his trap for traders is a kind of “harpoon” from the tale of the American children's writer Dr. Seuss. Buffett has also used hunting metaphors in this context for a long time - he says that “his elephant-hunting rifle is loaded”, meaning a big deal under the “elephant”. Buffett and Spitsnagel have one more thing in common - they both often attract investors with huge returns. “In the end, it’s big losses that spoil all the statistics,” says Spitsnagel.
Spitsnagel’s strategy worked not only in 2008. It provided Universa Investments with high returns both during the crisis of 2011, due to an increase in the maximum level of US government debt in order to prevent technical default, and during the collapse of the Chinese stock market in August 2015. After further measures by the U.S. government to increase the limit of public debt at the end of 2017 and early 2018, Universa Investments also managed to capitalize on the sharp surge in volatility that led to the collapse of the US market. The next chance to play for a fall was presented to Spitsnagel only in 2020. The main "black swan" of our time, the COVID-19 pandemic, quickly swept the whole world, which led to the collapse of world markets in just a couple of weeks.