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taleb as miseducator (part 1)
(as the word “miseducator” caused confusion on twitter, I’ll just explain the joke here - it’s a mashup of Nietszche’s essay “Schopenhauer As Educator” and the album title “The Miseducation Of Lauryn Hill”. That’s all, there’s no implied claim about anyone or anything, it’s just a joke)
If Nassim Taleb ever comes across as a bit grumpy in his public persona, consider this; he’s written four big books (Fooled By Randomness, The Black Swan, Antifragile and Skin in the Game) and every single one of them has been badly misused by both fans and critics. In fact, you can almost write a history of the twenty first century through the medium of abuses of Taleb.
Fooled by Randomness for example, popularised the concept of the “barbell portfolio”. A central point of that book is the difference between “normal” risks (those with defined probabilities, or which can be expected to converge to a bell curve) and wild risks, where things multiply together rather than adding up, and where extreme outcomes are much more common and important than you would guess by observing things in steady state. Another key point is that people overestimate their understanding of almost everything, because they usually see the manageable uncertainty and causally explainable outcomes, missing the contingency and the possibility of something happening which is way out of their experience.
At one point in the book, he mentions that this is the philosophy behind his personal investments – mostly very safe, risk-averse assets, with a small weighting in things he doesn’t understand, which are most likely completely worthless but might have a small chance of huge returns. That’s the “barbell” (it’s got portfolio weights on the ends of the risk-return spectrum but not in the middle).
One thing that should be noted up front is that this is a risk reduction strategy. The wild and crazy stuff isn’t really there to provide upside from a guaranteed baseline return. It’s there because you can’t be sure that the safe stuff is really safe. In one of the first reviews of FBR, John Kay gave us this thought experiment:
“think of a young college student in the USA in 1899, whose rich family want to set him up for life. His parents give him some Russian government bonds. His grandparents give him the title to part of their land holdings in Argentina. His other grandparents give him a 5% stake in the Erie Railroad.
“Go forward eighty years, and young Scoville is indeed able to die as a rich old man, without ever working a day in his life. But all his youthful endowments have ended up worthless. All his fortune is attributable to the few shares gifted by his disreputable uncle, who had a hot tip about a drug store owner in Atlanta making a soda drink out of cocaine leaves”.
The barbell portfolio was never meant to be an actual portfolio – it was (and is, in the later books, really clearly) a philosophical device, meant to make you think in a different way about your investment risks. Shall we say, this isn’t how the investment management industry took it.
As a friend recently said to me, the typical high-net-worth conversation was more likely to go along the lines of “I’ve got venture capital for the capital growth – I need some Credit Suisse bonds for the income”. I had one client in the 00s whose “barbell strategy” consisted of some FTSE100 shares for the safe bit, and then some different FTSE100 shares for the wild and crazy bit.
There were a lot of things going on in the 2000s – you obviously can’t blame the demand for safe assets on one book! But part of the pervasive philosophy of investment at the time was driven by people wanting to respect the distinction between “Mediocristan” and “Extremistan” that FBR introduced, without understanding that the point of Fooled by Randomness – which is right there in the title! – is that it’s all Extremistan, that Mediocristan is only a very small and special case, which is not applicable to most of daily life.
A sort of Envoi to this section – and a preview of the next one in this series which will be about the even worse understood The Black Swan – might be to address the vexed question of “did Taleb get it right on Fannie Mae?”. This is a vexed one; it drives people crazy when he says he did, because in the footnote in TBS where he says in 2003 that the GSEs are “sitting on a barrel of dynamite”, it’s pretty clear from context that he’s referring to interest rate mismatch risk, and it turned out that this was one of the few things which didn’t go wrong for them so much.
I think I’d say that he was about as right as the people who said that the World Trade Centre was likely to be bombed a second time after the 1993 attack. The specific means of terrorist attack wasn’t right, but the grand scheme of the prediction was that something was so big and prominent that it had to be vulnerable and that was correct.
Taleb’s footnote even has the sarcastic aside “But not to worry, their large staff of scientists deem these events 'unlikely’”, which to my mind is emphasising that the whole point of the prediction was that FNMA was so complicated that it was impossible to say what was safe and what wasn’t. So you have to score this a W.
There’s something psychologically intolerable about Taleb’s work to a lot of people, which is why so many of them want to simultaneously say it’s banal and exaggerated, that he’s way out of the mainstream but only saying things that everyone knows. (He also attracts a lot of the kind of people who could have been present at the Creation and would have still said that light was nothing new). This is also true of some other economic commentators (“Piketty as miseducator” and “Galbraith as miseducator” are definitely possible series for the future), and it’s a sure sign of something worth study.