Nassim Taleb: black swans, fat tails and the barbell strategy
A former options trader who argues that rare events matter more than averages. His idea of the barbell, why it is hard to see in a filing, and what the six portfolios reveal about risk.
Who he is
Nassim Nicholas Taleb is a Lebanese-American former options trader and essayist. He wrote Fooled by Randomness (2001), The Black Swan (2007) and Antifragile (2012), and is an adviser to Universa Investments, a fund that specialises in protection against extreme market falls. His style is deliberately combative, and his central claim is simple: the world is more uncertain than our models suggest, and we pay for ignoring it.
He is not a classic economist, and many professionals dislike his tone. But his argument about rare events has influenced risk managers and investors around the world.
The core ideas
A black swan, in his definition, is an event that is a surprise to the observer, has a very large impact and is explained afterwards as if it had been predictable. His point is that the distributions we use in finance, which assume that extreme moves are very rare, underestimate how often markets make large jumps. The tails of real distributions are fat.
From this he draws three practical ideas. First, avoid being hurt by the rare event: do not take risks where a single bad outcome ruins you, whatever the average looks like. Second, the turkey problem: a turkey fed every day for a thousand days concludes that life is safe, until the day before Thanksgiving, so a long calm record is not proof of safety. Third, antifragility, the idea of arranging things so that disorder helps you instead of harming you.
The barbell strategy
The practical form of these ideas is the barbell. Instead of a medium-risk portfolio, you put most of the money, he suggests about 85% to 90%, in something extremely safe, such as Treasury bills, and a small part, 10% to 15%, in very speculative assets with large possible payoffs, such as options far from the current price. The most you can lose is limited to the small part, while the chance of a large gain is kept open. He argues that the middle, which looks moderate, is the most dangerous, because its risk is hidden.
In this view a portfolio should be judged by its worst case, not by its average, and a strategy that makes small regular gains while exposing you to a rare large loss is, to use an old trading phrase, picking up pennies in front of a steamroller.
What six current portfolios show
A filing cannot show a barbell, because it leaves out exactly the safe half: cash, bonds and bills. This is a limit of our data, and it means that Berkshire, Baupost and others, which hold large amounts of cash, may be closer to a barbell than the table suggests. What can be seen is the risky side. Duquesne has about 16.4% of its reported book in options, valued at the underlying shares: calls on funds and on a single stock, a structure that gives limited loss and large upside.
At the other end, Pabrai's four positions, the largest 43.3% of his book, are the opposite of Taleb's advice, a concentrated bet on cyclical companies with no visible protection, although Pabrai would reply that he looks for cases where the downside is limited. And the average opened or closed share of 23.8% at Duquesne against 1.0% at Berkshire shows two very different attitudes to change.
Six real portfolios side by side, from the latest filing of each investor (Form 13F, US-listed stocks only). Effective positions is the number of equal-sized positions that would be as concentrated as the real portfolio: one divided by the sum of the squared shares. Opened or closed is the average over the four quarters of half the combined share of positions that were opened or closed.
| Investor | Reported stocks | Positions | Effective positions | Largest position | Ten largest | Opened or closed per quarter |
|---|---|---|---|---|---|---|
| Warren Buffett | $299.3 billion | 26 | 8.1 | 22.0% | 91.0% | 1.0% |
| Ray Dalio | $24.4 billion | 990 | 23.9 | 16.3% | 42.1% | 5.8% |
| Bill Ackman | $13.7 billion | 10 | 6.9 | 17.6% | 100.0% | 7.0% |
| Stanley Druckenmiller | $5.2 billion | 94 | 22.2 | 16.6% | 46.3% | 23.8% |
| Seth Klarman | $5.4 billion | 23 | 13.4 | 16.5% | 74.9% | 9.5% |
| Mohnish Pabrai | $0.3 billion | 4 | 2.9 | 43.3% | 100.0% | 4.4% |
Where it is challenged
Critics say that Taleb is better at diagnosis than at method. Barbell portfolios have a cost: the safe part earns little, and the speculative part loses most years, so you may bleed slowly for a long time before a crash pays. Defining the right amount and the right instrument is hard. And a lot depends on prices: options on rare events are expensive after a crisis and cheap in calm times, which is when you least want to buy them.
His tone and his disputes with other economists also make it difficult to separate the useful argument from the polemic. The central lesson, that you should look at what can go wrong, is widely accepted. The prescription is not.
What to take from it
Ask what the worst case is, not what the average is. Never take a risk that can end the game. Be suspicious of strategies that have a long calm record and a hidden large loss. Hold enough safe assets so that you can survive a bad period and act when others have to sell. And remember that a protection is a cost: it is paid for every year, in return for a benefit that may come once in a decade.
This is an explanation of an idea, not a recommendation to buy options or any other product.
Where it meets our bots
Several bots are about surviving the rare event. The permanent portfolio keeps a quarter in cash and a quarter in gold, and the 200-day trend bot moves into short-term bonds when the market falls below its long-term average. The volatility-targeting bot cuts the position when markets become jumpy. On the other side of the ledger, the bot that holds a triple-leveraged Nasdaq fund is the clearest example of a strategy that can lose more than half of its account, and we say so on its page.
The accounts are virtual and public, so a bad stretch is visible to everyone. The guides below explain the rules.
Related strategy guides
The permanent portfolio: stocks, bonds, gold and cash
TQQQ with a 200-day moving average filter
Volatility targeting: less stock when the market shakes
Portfolios
Portfolio builder
Set the shares of stocks, bonds, gold or take famous models, mix them, and see how such a portfolio lived through every era of history.
Goal finder
Say what you need — for example, 6 % a year over 10 years with a drop no deeper than −25 % — and see which models and mixes met it, and in what share of historical periods.
Retirement: how much to withdraw
The 4 % rule tested on 60 portfolios: which share of the money you could take out every year, and when it failed.