In the current market environment, sometimes safe-haven assets aren't guaranteed safe investments anymore. Universa Investments Founder and Chief Investment Officer Mark Spitznagel sits down with Yahoo Finance's Head of News Myles Udland to discuss his investment philosophy emphasizing cost-effective save-haven strategies.
"Risk mitigation can end up being the costliest thing we do as investors," Spitznagel explains on safe-haven assets. "We need to think of our safe havens as being cost-effective — which is something you don't often hear used in the investing industry simply because risk mitigation typically is not affected, hardly ever is — and cost is usually a cure that is worse than the disease."
Spitznagel calls Treasury yields "hopeful havens" while commenting on the bond market outlook amid the Fed's higher for longer interest rates.
MYLES UDLAND: Mark, thanks so much for coming up to New York.
Great to have you back in town for this.
I want to start with the title of the book, "Safe Haven".
And, of course, the role that plays in the work that you do at Universa, and thinking about the way that you approach markets, and really defining to you what qualifies as a safe haven, because I think it's different than the way many investors might think about it.
MARK SPITZNAGEL: Well, I mean, it's a broad subject.
I mean, obviously, safe havens are the things that we invest in to give us shelter from the storm, protection when markets are doing bad things, but it's just so much more complicated than that.
And what we-- I think what I end up sort of showing in my book, and what's so important to me, is a sort of a risk mitigator as a profession is that risk mitigation can end up really being the costliest thing we do as investors.
So that's kind of the point that I get into in talking about safe havens.
And it's sort of the counter-intuitive aspect of it.
We need to think about our safe havens as being cost-effective, which is something that you don't often hear used in the investing industry simply because safe havens, or risk mitigation, typically is not in fact, it hardly ever is.
It's usually something that causes, it's usually the cure that's worse than the disease.
MYLES UDLAND: And I'm curious also, the role that writing plays in your process as an investor.
Because you can kind of go through the Warren Buffetts of the world, Howard Marks has written, and the way that you maybe think through writing frankly, as an investor and how that's fit in your experience, where you see that going forward?
And frankly, why write a book?
You've got plenty of other things going on.
And why this maybe helps you and your firm fine-tune your process, in a way?
MARK SPITZNAGEL: Yeah.
Writing, to me, is basically introspection.
It gets you thinking about the basics, the whys.
It gets you thinking about first principles, from my standpoint.
To me, what's the greatest first principle from what I do, it's why do people not only invest, what's their purpose or goal as an investor, what's their purpose or goal in risk mitigation.
It seems like such an obvious thing, but actually we would not agree on what that is.
People in the finance industry would not agree with me on what that is.
They would say it's something like some utility function, or mean-variance, information ratios.
I would say the purpose of investing is the same as the purpose of mitigating risk, that's to raise your wealth over time, raise the-- lower the range of that wealth in the future, and raise it.
That's a crazy thing to say, actually.
But we face this problem as investors.
I call it the dilemma of risk, the great dilemma of risk.
If you take too much risk it costs you over time.
You can't use leverage.
If you take too little risk it costs you over time.
This is precisely the problem that pension funds are dealing with in their under-funding problem.
Is it too much or too little?
Sometime, somehow, you've just got to thread that needle.
But I think that if we think about this, and again, going back to your question, just think about this on a first principles basis, maybe it's the case that taking risk and not enough risk, offense versus defense, maybe that's just two sides of the same coin.
And I think that it is.
I think that the reason we mitigate risk is actually to do a better job being offensive.
I mean, there's a Sun Tzu quote that attack is really the secret to defense, and the defense is the planning of an attack, right?
We could all agree in this room that over the next 20 years, I'm the most bearish guy you're ever going to meet.
But we could all agree in this room that in the next 20 years probably the S&P is the best thing to be.
And if you could make one trade right now it's probably buy the S&P right, despite what's going on and how expensive it is today.
So we know that mitigating risk really isn't about where we think the world is going to be.
Mitigating risk is about is what that path is going to look like, and the opportunities that you have along that path, right?
The dry powder that you create.
So we need to think about offense and defense in very much the same way.
MYLES UDLAND: It's like, I guess, it allows you to be more long, some people would say.
Is that maybe like-- as your speaking, that kind of comes to me, this notion of the reason you would be taking insurance out, the reason you would be short anything, is you can make bigger bets on that future you're talking about.
MARK SPITZNAGEL: Yeah, but it doesn't typically work that way.
Typically, most risk mitigation, as we know it, choose your canonical safe haven risk mitigation strategy, whether it's a hedge fund or a bonds, they are really more of a dilution of risk.
So that's really not allowing you to be more along.
That's the opposite.
That's making you less long.
So somehow, along this path that I described of the next, let's say, 20 years, you've got to find ways of having that dry powder when the moments the greatest.
It sounds to me like it requires being some kind of tactical edge to do that.
Of course, none of us have that.
So this is the problem.
This is why most risk mitigation strategies are the cure that's worse than the disease.
And most risk mitigation is the costliest thing that people do.
MYLES UDLAND: And so one of those you write about in the book is treasuries.
And I'm just curious what you've made maybe over the last two months we've seen across the curve, and is this essentially-- my reading of the book, watching the markets, it's like well, this is proving the point, sort of where you get into trouble with this.
But I'm just curious what you make of the move we've seen in treasuries.
And what it is indicative to you, if anything, of this market moment?
MARK SPITZNAGEL: Treasuries are not a safe haven.
I say this in the book, they're very much a hopeful haven.
So, yeah, I mean, they have their place.
I think that they're pretty cheap right now, frankly, so I don't want to trash them too much.
But as a strategic-- MYLES UDLAND: They won't take it personally.
MARK SPITZNAGEL: As a strategic risk mitigation strategy, they're highly statistical, they're not mechanical.
It's a difficult thing to rely on.
But this is what the world relies on in this sort of canonical 60/40 portfolio.
But the major point that I make in this book is that not all risks are the same.
And we need to always remember that treasuries, to answer your question about treasuries, they just don't address that very well.
In much like any other normal risk, any hedge fund or whatever, they just don't address the non-linear nature of risk.
I, as a business, we protect very large losses.
That's what we're there for.
It's not just because they're scary.
It's not just because they're large.
It's not just because they make headlines.
It's because they actually, mathematically, it's what matters.
The little losses don't matter, it's the big ones.
Because, going back to what I said before, the purpose of risk mitigation should be to raise your terminal wealth at some point over time.
And what that means, the equivalent of saying that, is that it should raise your rate of compounding over time.
Not your mean-variance, but your rate of compounding, your geometric average return.
And it turns out that geometric average return is a very counterintuitive funny thing that we just don't really understand.
We think of our returns linearly.
You look at a -10% or plus 6%--- we look at that as a linear number, right?
it goes into an arithmetic average.
Whereas what really happens in compounding is, the more you lose, the more that actually has an over-weighted bearing on your compounding.
You can just think about this intuitively.
You lose 50% one period, you've got to make back 100% the next.
So there is an asymmetry there.
And of course, that non-linearity, it's not just 2 to 1, it gets worse and worse and worse.
The closer you get to losing a hundred, the closer you get to having to make infinity to make it back, right?
So there's a huge non-linearity there.
And it turns out that the only way you can do what I was describing, which is to raise your rate of compounding as a goal of risk mitigation, is to focus on these big losses because those are the things that impact your rate of compounding.
Going back to that 20-year horizon?
Right now, looking back 20 years, that CH compounding growth rate was about 9.5% or so, going back 20 years.
But if instead we go back to the lows of 2020 and look at-- and recalculate that 20-year CAGR, it was down to 4%.
You can see how-- it happens that in that 20 years, you were starring at the peak of the dot-com era and, of course, you're looking at the low.
But that was really costly.
That 4% right there, that cost you about over 4x in incremental terminal wealth.
That's a really big deal.
MYLES UDLAND: And I guess I think about it as a normal person who has the majority of his money in the S&P, any of that's invested.
I feel like reading your work.
And even just talking here, like am I timing the market in a way that I hadn't thought about?
Because you can do the math, all 20-year rolling periods are positive, on average, over time.
But that doesn't really account for the fact of, well, if I had ended in 2008, that certainly wasn't there to save me, or I was going to have some problems with that.
Is that maybe something that I am not thinking enough about, or that is a way that, perhaps even worse, professional investors are not thinking about when they're advising their clients on what it really means to have a long time horizon.
MARK SPITZNAGEL: For sure, for sure.
And that is because the whole industry, all the modern finance, is based on this idea of modern portfolio theory, which is this-- it's this basic idea that you-- what we want to do is we want to maximize this ratio of arithmetic average returns.
Not compound average returns, but arithmetic average returns to risk or volatility, or however you want to measure.
They would use volatility.
If you're doing something good with that ratio, the idea is you're doing something productive.
Whereas-- even if it's making you poorer.
So I would argue that this is sort of a superficial narrative.
You know, it's said that diversification-- and that really is what we're talking about here, bonds, whatever it is.
We're talking about diversifying portfolios.
What Peter Lynch calls appropriately, "deworsefying" portfolios.
This has been called by great luminaries like Dalio, the Holy Grail of investing.
That is a lie.
That is not the Holy Grail of investing.
There is no Holy Grail of investing.
That is actually the cure that is worse than the disease.
What modern portfolio theory does is it optimizes a problem, the wrong problem.
It's optimizing a problem that's optimizable, which is this-- which has the machinery for this mean variance Sharpe ratio space, even though it makes you poorer.
So it's a huge problem.
But the reason they do it is understandable.
Like I said, it's the problem that's optimizable.
When we start trying to think about compound growth rates, terminal wealth, as a goal for our risk mitigation strategies, that's something that becomes really, really hard.
it's almost impossible.
In fact, I think I've shown in my book, mathematically you have to focus on the big losses to even have a chance to do it.
You really have to go about it.
It looks very self-serving, but it's just kind of a mathematical fact.
It's not esoteric.
It's the math of the way compounding and the world works.
You have to focus on the big losses.
MYLES UDLAND: And maybe the way that modern portfolio theory was best exported to myself and the other common folk in the room is 60/40 portfolios.
And we've seen they've had a challenging couple of years.
And I'm imagining, from your seat you, see these numbers on these returns, and the number of people who have been pushed into these, and you're saying, well, of course.
I mean, this is exactly why this is not the kind of balance, or diversification perhaps, that may be suggested when you get a quick one-shooter.
MARK SPITZNAGEL: Well, it's easy to pick on 60/40 now because bonds have just been destroyed, right?
So I'm not going to kick them while they're down.
It's so obvious, right?
But I would have said this three years ago, four or five years ago.
When diversification, "deworsefication", gets a win, which maybe, maybe, you lose less in a crash, let's say, it's like it's a pyrrhic victory, because you end up paying for it in the recovery.
It's a double-edged sword, right?
You'll get cut by it.
It is very much-- and we know these pyrrhic victories.
It's a cliche.
Governments are famous for it, right?
In my book, I talk about the SS Eastland, where in 1912, the tragedy of the Titanic, now all of a sudden, the government gave regulations on needing a certain amount of lifeboats on board.
And three years later, after the Titanic, the SS Eastland capsized in the Chicago River because of the weight of these lifeboats, killing more paying passengers than died on the Titanic.
That's very much the right way to think about modern portfolio theory, diversifying strategies, in general.
They're a pyrrhic victory.
MYLES UDLAND: And on that.
It makes me think of another analogy that comes up in the book, which is the Fed and forest firefighters, and the way that those two organizations, let's see, share a common approach to managing risk.
And I'm curious how you see that in this current moment?
We're always constantly talking about the Fed, et cetera, et cetera.
But just where do you see them in their journey and maybe where they have failed markets in the past, failing them today, if they are, and what the evolution of monetary policy essentially in this market might be to you?
MARK SPITZNAGEL: Yeah, monetary policy is the most destructive force in the global economy.
It's taken a natural, healthy homeostatic process, which is crashes, bankruptcy, recession, and it's turned it into something that is-- it is dangerous and destructive.
This is what they've done in eliminating-- trying to eliminate recessions and crashes.
They've turned it into-- they've created this tinderbox, right?
I go over it ad nauseam in my first book.
They've created a tinderbox.
So it's the same kind of, what I call, risk mitigation irony, right?
They tried-- the government is there to ultimately try to mitigate these risks for us, and they end up just making it worse, right?
But-- and that's-- we get that.
But in finance, shouldn't it be that risk mitigation costs less than the very thing would cost that you're trying to mitigate against happening, right?
Shouldn't it be that way?
It's so obvious, but nobody would agree with me in this industry, right?
But no, we're living in a tinderbox time bomb.
MYLES UDLAND: And so, as we kind of get to the end of our conversation, I'm curious what are our audience perhaps can take away, in terms of either actions they should take or just frameworks that they can now apply to their own strategies?
Because I don't think that I'm going to meet the minimum for investing with Universa, and I don't know how many people will.
But there are certainly things that you guys are doing that can be applicable, or ways, frameworks, that people can approach their own investing.
What was something that you might tell someone who-- I guess, I just asked the question, so.
MARK SPITZNAGEL: Yeah, and I get this all the time.
And none of the things that I do retail investors can do.
And it looks like I'm teasing, but nothing could be further from the truth.
And because I think the mindset is so important, be discerning about risk mitigation, understanding that your risk mitigation strategy, the way you allocate your capital in order to mitigate risk, is going to be the most costly thing that you do, right?
That in of itself, I think, moves the needle.
But I recognize that I also look-- I'm here saying that risk mitigation ultimately is not cost-effective and don't do it.
And at the same time, we are in the biggest credit bubble in human history, in my opinion.
And I don't think that should be a controversial statement.
That seems a little bit hypocritical, right?
Like you shouldn't mitigate risk for that.
But I don't think it is hypocritical because, at the same time, I think that anybody who is trying to prepare for that, I think that the market is set up right now such that they'll get they'll get squeezed out of their position.
I think there's probably another run or two left before we actually see that.
I've been saying that for a year.
So, anybody who actually tries to mitigate risk, they're not going to be able to keep it.
That is the problem.
I mean, ultimately you need to think of risk mitigation not as protecting yourself from the markets, but I think, more than anything else, protecting yourself from yourself, from the really stupid things that we all do.
And this applies to professionals, too.
I mean, look how short people have been this year.
Look how short people were last fall, how short they are right now, right, or under-invested.
The markets make us do really stupid things.
And we just need to set up our portfolio to protect us from that.
MYLES UDLAND: All right, Mark Spitznagel.
We'll leave it there.
Thanks so much for the time.
MARK SPITZNAGEL: My pleasure.