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Yahoo Finance Presents: Universa Investments Founder and CIO Mark Spitznagel

On this episode of Yahoo Finance Presents, Universa Investments Founder and CIO Mark Spitznagel sat down with Yahoo Finance's Julia La Roche to discuss his new book, 'Safe Haven: Investing for Financial Storms'. He discusses Universa's strategies on risk mitigation, the dogma of diversifcation, pension funds, and modern portfolio theory. He also discusses his history as a pit trader, the Fed's manipulation of interest rates, and his views on gold, bonds, and crypto.

Video Transcript

[MUSIC PLAYING]

JULIA LA ROCHE: Welcome to "Yahoo Finance Presents." I'm pleased to bring in our guest today, Mark Spitznagel, the founder and chief investment officer of Universa Investments, a hedge fund that specializes in convex tail hedging and investing. He's also the author of a new book, "Safe Haven, Investing for Financial Storms." Mark, great to have you here today.

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MARK SPITZNAGEL: My pleasure, Julia.

JULIA LA ROCHE: Well, you know, you rarely give interviews, and that's why it's also great to have you. And you know, you might come across as a bit of a mystery to some folks out there. And in your new book, "Safe Haven," you position yourself in a bit more of a contrarian light. Yet when one looks at the returns of Universa Investments, you all, over the last 11+ years, have averaged north of 100%, according to audited returns from Ernst & Young.

And again, as I mentioned, you come across as a bit of a contrarian in this book. And you know, when I look at returns like that, it makes me wonder, Mark, what are people missing? How do you juxtapose people thinking you're a contrarian with this evidence, the returns here, showing how successful you all have been?

MARK SPITZNAGEL: Yeah, that's a good question because it is true that the way Universa invests is really probably the most bearish expression that one could have as an investor. And yet, at the same time, you know, my clients want the markets to go up. So why is that? It's obviously because it's a risk mitigation strategy. It's a particularly efficient and explosive risk mitigation strategy.

But you know, so when you think about the returns of what we do on it's own, you know, I can't speak too much about that. But you know, as a trader and investor, I sort of wear two hats. One is sort of a prop trading hat, where we think about edge and sort of long-run average returns over the-- on a standalone basis. And then there's-- we wear our risk mitigation hat. And that is, what do we do to the end user's portfolio? How do we transform that end user's portfolio by mitigating the systematic risks in that end user's portfolio?

And the two are very different. I mean, you have to think about them differently. Now, it's really the risk mitigation that I would argue is more important. I mean, clearly, I've been doing this a quarter century. So you know, there's a lot of tricks to this, and we feel like we certainly have demonstrated edge in our approach.

But kind of the point of my book is that, really, risk mitigation, we shouldn't look at the parts in that way. We shouldn't look at, sort of in a reductionist way, the parts in a risk mitigation strategy, but rather it's what you get from the whole. And certainly, you know, as the adage goes, the whole is-- it can be very different than the sum of the parts. And that can be true in risk mitigation. It needs to be true for risk mitigation to be cost effective.

JULIA LA ROCHE: You know, it's an interesting point you bring up. And I should also note that what you've written here, you've said this is the manifesto of you and your hedge fund firm, Universa Investments. And as you were just talking about. This idea of risk mitigation, what is it that folks generally get wrong about this concept?

MARK SPITZNAGEL: Well, unfortunately, when it comes to risk mitigation, we just approach it wrong from the start. Our goals are even wrong. And this-- you know, really, we have modern portfolio theory to thank us for this. But it's just kind of a heuristic of investing that you need to take more risk in order to get higher returns, in order to get more wealth at the end of the day. And as you take less risk, your returns are going to go down.

So it creates something of this sort of dilemma. I call it, you know, the great, great dilemma of risk. We're really damned if we do, we're damned if we don't. If you don't take enough risk, you're not going to get enough return. You take too much risk, and you know, you certainly are vulnerable to things, the types of crashes we've seen in the recent past and lowering your return.

So somehow, modern portfolio theory, we've got to find some middle ground, and we've got to get our Sharpe ratio right. And then we're going to, you know, crazy-- add some kind of crazy leverage in order to somehow be better off at the end of the day. To me, none of that really makes sense. It's really a sort of financial theater or a storytelling is what modern finance is all about. And it-- really, I just don't think it leads people in the right direction.

So I guess it just-- really, where people get it wrong is thinking about it as a trade off. And there really is another way. Risk-- the goal of risk mitigation, like the goal of investing, shouldn't be to lower volatility at the cost of returns. The goal of risk mitigation, like the goal of investing, should be to raise the rate of compounding over time. And again, flies in the face of everything we know from modern finance. But it is actually a reasonable expectation and it's a reasonable goal to have, even though it's difficult to achieve.

JULIA LA ROCHE: Yeah, you see it differently, you know, that cost-effective risk mitigation should actually raise a portfolio's CAGR over time. I want to circle back, though, to this idea of this great dilemma of risk and explore that a bit further. You know, because you think when you put something in your portfolio as an investor, you put it in there because you want it to make you wealthier. Is that correct? And I want to dig in a bit more. And you know, why is it that folks are missing this idea that you've put forward here?

MARK SPITZNAGEL: Well, again, I just don't think that we've sort of taken this first principles approach to thinking about what it is we're trying to accomplish. So we just kind of jump into it. We jump into this idea of diversifying our portfolio without even first asking ourselves why we're doing it and what we expect to accomplish in doing it.

And this is sort of my whole point in bothering to put these words to paper is I do think people need to think about this from a higher level, a first principles approach to what it is we actually want to do. As we build-- investing is, after all, allocating capital to different things in a portfolio. And modern finance tells us this is all about sort of this dogma of diversification. But as the great Peter Lynch calls it and as I borrow, this really ends up diworsifying one's portfolio. So again, it sort of begs the question, what was the point of it all?

JULIA LA ROCHE: Yeah, diworsification, I like that way of putting it. I want to step back. Do you think that maybe some of this-- you know, kind of like the modern finance dogma here, has kind of led us to the situation we've-- I've heard other, you know, well-known investors talk about the underfunded pensions and liabilities and some of the challenges that those will eventually-- I guess they'll eventually encounter down the road. Do you think this has kind of gotten us to that place? Has this contributed to some of those challenges?

MARK SPITZNAGEL: Yeah, I think you are-- you hit the nail on the head right there. This is the great dilemma of risk at play in the marketplace. You can see-- we see it-- you can sort of pick your penchant. One either has to sort of roll the dice and kind of go for it to avoid that underfunding problem, or one sort of cowers in the weeds, you know, in order to avoid that underfunding problem. Neither are going to get them to where they need to be. We saw what happened when too much risk was taken when we saw various financial crashes in the past, and then we can see what happens when these underfunded pensions don't take enough risk.

So they're kind of trapped in the middle here. And unfortunately, modern finance, modern portfolio theory just can't help solve that problem without the use of leverage, which in and of itself is, as I said before, is just a crazy idea that one needs to embed leverage in one's portfolio in order for the risk mitigation to be effective. Whenever someone is offered that as a solution, they should run away, I would argue.

JULIA LA ROCHE: You know, it's interesting, some of these kind of like conventions of modern finance. Why do you think it is this way? Is this just, like, human behavior? I know you're someone who studies, you know, the philosophers and, you know, maybe some of the human behavior here. What do you-- again, kind of narrow it down. What do you think it is?

MARK SPITZNAGEL: Well, you know, there's a little bit of a history lesson here that we were set on the right path a few years ago by Daniel Granulli. He kind of figured it all out for us, what risk mitigation is about and how it really is about raising the rate of compounding and how that is possible. But you know, it kind of happened in mid-century where, you know, without naming names, we just-- model portfolio theory kind of sprung out of this very reductionist view on building a portfolio. And the math was very convenient. I think that's a big part of the problem is it's sort of we start with a solution then we try to find a problem to solve.

Mean variance approach works nicely with the mathematical tools that we have. And using this sort of approach where we maximize the geometric average, our rate of compounding, which is, like I-- like, you know, we've been talking about-- is really all that really matters in investing? That doesn't lend itself to the clean math, necessarily, that modern portfolio theory gave us. So I think that's part of the problem is we've got sort of financial engineers with a solution to-- first and then finding a problem without first analyzing what the problem is and seeing what the right approach is.

JULIA LA ROCHE: I want to bring up your background. So again, you have a-- your way of investing, it's obviously paid off. You know, last year, there was a lot of attention around Universa Investments returning 4,000% in the first quarter. You all do well when these financial storms happen. What was in your background-- you mentioned at the top of this conversation, you know, being in the pits in Chicago, and you also take this where mathematical, quantitative approach to investing, looking at the markets, also looking at-- you know, studying the philosophers, if you will. How did your background kind of lead you here?

MARK SPITZNAGEL: Well, my background as a pit trader was really all about focusing on taking small losses, minimizing your losses when you're wrong such that you can maximize them when you're right. And I think that's sort of relevant-- you know, when people think about returns, your news about returns in crashes that Universa has. I mean, I always like to de-emphasize that because really, at the end of the day, any punter can devise a trade that does well in a crash. The key is how do you do in a crash-- an insurance-like payoff like Universa's, how do you do in a crash relative to the rest of the time? So that's really what matters, so these long swaths of time that really matter. And the key to that is, you know, sort of maximizing the asymmetry of that payoff.

And as a pit trader, this is kind of what I was taught, really, starting as a teenager, that this is what trading is. Trading is taking very small losses and taking very large profits. And of course, being taught this-- what happened was I was taught this at a very impressionable age, something that is diametrically opposed to the way pretty much all hedge funds operate, which is take a lot of little losses and occasionally maybe experience some type of a negative tail event.

JULIA LA ROCHE: I want to step back for a sec from your book. I know in your first book, "The Dao of Capital," you do you-- talk about monetary policy. And it's no secret that you have been outspoken on the Federal Reserve. Kind of framing up though what's transpired-- you know, markets reaching new highs, unprecedented monetary experiment that we've been on for several years now-- how do you kind of think about the Federal Reserve, Mark?

MARK SPITZNAGEL: Well, so the Federal-- it's-- what the Federal Reserve is manipulating, the most important sort of information parameter in the economy. That's interest rates. So I think we need to sort of-- occasionally, we need to remind ourselves that financial markets-- you know, we all this idea of supply and demand in financial markets. Financial markets are this great homeostatic system and they-- with sort of these-- sort of corrective feedback mechanism. And the control parameter, of course, are prices. And really, the one-- the big one, the biggest of them all is interest rates, or the price of time, if you will.

And so by manipulating that interest rate, which is what central banks do, what they're basically doing is messing with that homeostatic process, that corrective process. Because basically, all the interest rate does is it regulates debt and savings, right? As debt accumulates, relative to savings, we see interest rates go up. And as savings starts to grow, as relative to the demand for debt or credit, we see them go down. And that sort of regulates them. It's sort of a crowding out effect.

We all know that interest-- that the price mechanism has this-- serves this function in sort of everyday items in the economy. But of course, the interest rate is even more important because it kind of regulates everything. It regulates all sort of capitalistic activity and savings and borrowing.

But what happens when we manipulate that, now we have this sort of Hayek-- what the Austrians would call a Hayekian information problem. No longer is information conveyed by the interest rate. So what does that do? It sort of rips apart this great homeostatic mechanism that it is the marketplace. But I would argue it doesn't remove it. It basically just sort of delays it and sort of concentrates it in time.

So think about-- I think a good way to think about this is when you're driving. You know, driving is very much this sort of feedback mechanism where you make these minor corrections. And that's-- I think that's a good way to think about what the market does, the price system does. But think, when you drive on ice, all of a sudden, you have this delayed feedback so that when you do something, nothing happens until all of a sudden it does. And I think that's really the way we should think about what central bank interventions do to this homeostatic system is they delay it and they concentrate it through time such that ultimately, you know, history shows-- and logic, I think, dictates-- that ultimately, sort of this homeostatic corrective feedback mechanism rears its angry head. And that's what the crash is. But it just-- it's made worse and it's delayed through this central bank interventionism.

JULIA LA ROCHE: So are-- I know no one has a crystal ball here, and you talk about no one can predict the future. But I mean, how do you kind of even think about probabilities of the long-term consequences? Like, if it does rear its ugly head, are we talking about financial crises that could be even worse than the ones, I mean, I've experienced in my lifetime or maybe you've seen in your lifetime?

MARK SPITZNAGEL: That would be my expectation. But having said that, so I don't have to trade with that expectation. I remain very much agnostic to all this, which you kind of led with at the start of this. That's important, and I think it's important to invest in a way that you don't rely on this sort of grandiose forecast. I think it's a misnomer when people think that investing is about forecasting. I think that generally everybody agrees that, but it really shouldn't be about forecasting.

It really-- it should be about-- it shouldn't just be about forecasting this sort of expectation because that-- we're never going to get that right. We're never going to get that right. And of course, the range around these expectations, we forget, is massive. It's just massive.

So how do you trade based on-- or invest based on one expected value? You'll get one path. You know, we just get one path. We don't get an average across all possible paths in the multiverse, right? We get just one. So it's a little bit crazy to invest based on that one. So we do need to be agnostic to that-- easier said than done. So I do have the luxury of thinking about this without having to sort of bet my beliefs in that sense.

JULIA LA ROCHE: I like that you said that you remain agnostic and you get the one path in the multiverse. But not everyone's wired that way. I don't know if it's something you think about but, like, if we go back to kind of thinking about human behavior in general, it does kind of make you wonder, though, what kind of the longer-term consequences of this could be. We've seen more people enter this market, especially in the last, I mean, year plus. So just kind of how you think about it philosophically, like our markets in general and, you know, really, the dependency here on the Fed.

MARK SPITZNAGEL: Yeah, unfortunately, I think we have a majority of people active in the marketplace now that don't have this concept of a range of outcomes that we will see, we could see, we were randomly selecting from. I think that's a concept that would be lost on most people, that they have one expectation. They're going to-- damn it, they're going to invest or trade based on that.

But you know, when you think of-- another way to think about this in terms of risk mitigation is that, you know, across this whole range of possible ways that things can go, if it's-- if your risk mitigation strategy still doesn't give you some good payoff, even should we see a crash and a recovery like we've seen in the past, if you still find yourself underwater and poorer because of it, that's another indication that, you know, when it comes to risk mitigation, the cure is often far worse than the disease itself.

So though I am telling you that I have this expectation of sort of destruction in the future in the financial markets, that doesn't necessarily mean that someone should just hide away because that in and of itself may not be the best strategy either. You know, that's kind of like the dogma of diversification, thinking that just by lowering your risk, it's going to be better for you.

There needs to be a-- people need to think that through more carefully. But again, I think that if you just approach this knowing what your goals are, realizing that your risk mitigation may be costly. It may be costly even if we see the crash that someone expects, you may be poorer for it. And as long as people understand that that wasn't the goal, that least we're being consistent in our approach.

JULIA LA ROCHE: And you know, I like in the book how you talk about-- you do address kind of the everyday investor, probably the investor our audience is comprised of, the kind of retail investor that this is not a how-to book. It's a why-to book. And you know, kind of if we stay on this topic of, you know, safe havens or maybe some of, like, the myths around safe havens, a couple I want to kick off with you and just explore as to why it's not a safe haven. Let's start with gold. How should people be thinking about gold? That's not the safe haven that you might expect it to be, the one that's often talked about.

MARK SPITZNAGEL: Well, as I show in the book, it's just rather inconsistent. There's a lot-- there's-- historically, there's been a huge range of-- around how it's done mitigating the systematic risk in a portfolio. It's actually pretty darn good. It relies, certainly, on these inflationary expectations that we've seen in the past. It remains to be seen if that's even the environment we're really going to go into. So gold is pretty darn good. I mean, I-- you just have to understand that there's been a lot of noise around it.

JULIA LA ROCHE: It's more like tactical, I think is one way of putting it.

MARK SPITZNAGEL: It is tactical.

JULIA LA ROCHE: Yeah.

MARK SPITZNAGEL: So-- which is a great thing to bring up. There's-- we need to juxtapose tactical safe havens versus strategic safe havens. So strategic would be something that you should always have in your portfolio, allows agnosticism, whereas tactical it's something where you really have to have a view and you better be right in that view or it's not going to do anything for you. And it's kind of inconsistent with the whole notion of risk mitigation in the first place, which kind of presumes that we don't have a crystal ball.

JULIA LA ROCHE: You know, another one that's come up lately in recent years-- you probably know where I'm going-- is Bitcoin and cryptocurrencies in general. Maybe you've seen some of the folks talking about maybe that one being an inflation hedge, certainly a lot of rhetoric around it. What do you make of cryptocurrencies and Bitcoin? Do you think that could be a safe haven?

MARK SPITZNAGEL: I think it's a very-- OK, once again, it's a massively noisy space. We just don't know. So this is as tactical as it gets. You know, I do think it's a fundamentally terrific idea, the notion of cryptocurrencies. You know, and in general, I'm aligned with the thinking behind it and aligned with many of the people who are positive on it. And I think we're thinking about it in the right way. We're thinking about, you know, the destruction of our money through the actions of central banks and we're thinking about, you know, the dangers of the banking system as a result of that.

So I think that people are thinking about it right. But unfortunately, as terrific an idea as that is, it's turned itself sort of in a casino, which is a very bad idea. So it's kind of like killing the golden goose, I fear, in many ways. So as a safe haven, I would argue that's not a very good safe haven at all. But I do think that it's a-- again, it's a terrific idea.

JULIA LA ROCHE: Terrific idea. Do you own any, maybe personally? Or I mean, I doubt Universa does. But have you dabbled in cryptocurrencies?

MARK SPITZNAGEL: I probably shouldn't talk about that.

JULIA LA ROCHE: OK, no problem. Let's bring up treasuries. I'm curious your thoughts. Because that's kind of like, when you think of structuring a portfolio, you know, the old adage-- what, was, like, 60-40. So how do you think about-- how should investors think about bonds in their portfolio?

MARK SPITZNAGEL: Well, particularly today, of course, with rates being where they are, I think it's very challenging to think of that as something that's going to be cost effective. I don't see how it could possibly-- it's-- you know, you really have to look in the past, and you'd struggle to find how even bonds were cost effective historically. You'd have to really have reached for-- reach on the yield curve in order for them to have that.

Really, you know, the way most people would invest in sort of shorter-date bonds, it's really-- bonds really represent sort of, I think, the canonical case of sort of the mean variance approach of lowering the volatility in a portfolio but being poorer because of it. But again, where we are today makes it all the more challenging. I think it would be very hard for bonds to have-- to, going forward, provide cost effectiveness when even in the past they really weren't able to do that.

But of course, bonds are the canonical safe haven. Really, I mean, it's what people think of when they think of risk mitigation, when they think of diversification and balancing a portfolio. And I think that right there is-- I think to focus on that is really focusing on the problem of our goals-- not really, I think, being clear about our goals.

JULIA LA ROCHE: You know, I will say this. Your book is incredibly thought provoking. I've seen a lot of folks talking about it, even saying that it's going to cause them to rethink how they want to allocate to a portfolio. So again, not everyone can replicate what you do at Universa, certainly, but they can learn lessons here, especially around risk mitigation. So I guess to leave our viewers some parting thoughts-- again, I know it's not a how-to book, but what would you say to that kind of retail investor audience? What would be the biggest takeaway from them when it comes to, like, relooking at their own portfolio allocation?

MARK SPITZNAGEL: Well, again, what I try to provide for people is certainly not a how-to book. I mean, you're never going-- no book is ever going to tell you what to do as successfully as an investor. If someone ever claims that, I would recommend against very much.

You know, what I try to provide is a sort of logical, practical framework, really, just for approaching risk mitigation, thinking about risk mitigation, thinking about safe havens, and thinking about the goals, what it is that we want, what our expectations for them should be in the first place. Are we-- does it require some grandiose crystal ball in order to be effective, or should risk mitigation be something much more than that? Should it be there specifically because we don't have that grand crystal ball?

So to me, that's much more powerful for a retail investor than some random trade that wouldn't even be relevant in two days, right? So yeah, and I do think that if people think about that and it gets them to revisit, again-- and I don't-- I think that the investment profession shouldn't be too happy about that because I think there's so much storytelling, narrative, even snake oil being sold in this sort of-- in the name of this dogma of diversification without-- that's basically just making people poorer and not really even providing very much risk mitigation for it. I think that there's a lot of forces out there that don't want people to revisit the sort of practical framework that they're using in approaching portfolio allocation.

JULIA LA ROCHE: Yeah, sounds like that part of the financial system could be ripe for some disruption, maybe some awakening here to some of the ideas that you share here and "Safe Haven."

MARK SPITZNAGEL: I think you're right.

JULIA LA ROCHE: Well, Mark Spitznagel, the founder and chief investment officer of Universa Investments and the author of "Safe Haven, Investing for Financial Storms," I thank you so much for joining us on "Yahoo Finance Presents."

MARK SPITZNAGEL: Thank you, Julia. It was my pleasure.