Nassim Taleb's five ways to beat black swans

By:
Published on:

Author and former trader Nassim Taleb, who shook the financial world with his best-selling book on risk The Black Swan, recently spoke at an RBS Insight dinner for clients in Milan. Here, he shares his thoughts on handling the unpredictable.

1) Accept unpredictability

There are two ways to think about things. Some like to know exactly what they are looking for and need to predict their environment with a lot of precision. Others accept that random events can interfere with what they are doing.

The issue is that our environment is fundamentally unpredictable. At a company, not only can you not predict your own sales, you could never predict the sales of all your competitors.

There are people who want to rigidly follow a map to get them through life and those that realise they need a structure that allows them to take a wrong turn and still survive. You want to turn every random event that befalls you into opportunity. That’s antifragile.

2) Always have a cash cow

Around 70, 80, perhaps even 90 per cent of what you do should be low risk – a cash cow or safe game will close to zero the probability of ruin. You can then afford to use the rest of your energy focusing on what’s going to make you rich. It is better to have a dual strategy with high risks coupled with low risks, ensuring survival while seizing large opportunities.

3) Small is beautiful

Large companies are far more vulnerable to unforeseen events than small firms. It’s not just about the size of the business but the size of the economic decision unit. Companies that make cars or planes will have different exposure to those that make books. It’s about being small within the boundaries of your particular line of work.

This goes for systems too. A country that has lots of bits and pieces is vastly more robust than one that is too concentrated. Systems that survive find sweet spots between economies of scale and diseconomies of risk. This risk, after all, grows much faster than size if things go wrong.

Italy and Germany have found this sweet spot, benefitting from corporate sectors that are quite fragmented.

4) Have the right kind of luck

I believe in luck, but it’s very clear that there are two different kinds of exposure.

There are random events that can help you a lot or harm you very little. And there are those that can harm you a lot or help you very little.

If a pharmaceutical company introduces a new drug, the worst that can happen is that it does its job, but it might turn out to be the cure for something else.

On the other hand, if you get on a two-hour flight there is no random event that can get you to your destination much faster, but you could be severely delayed. Obviously in a case like that we have to do it anyway, but where we can, we should be mindful of taking risks with little upside.

This is the ability to be opportunistic. Nokia has done this very well and has been quite aggressive in changing its business over the years. It started out making paper and rubber boots before entering the cellular phone market.

5) You cannot predict the next black swan

I am often asked what the next big black swan will be. It’s a question that misses the point of my ideas of focusing on robustness instead.

Black swans are what you perceive to be highly improbable, but others may feel differently – Christmas is a black swan for the turkey, not the butcher, because the turkey doesn’t know what’s coming.

There’s no point trying to predict which black swan will happen, that’s impossible. All you can do is ensure you have good risk management in place and options to take advantage of such events. Since they happen, let’s embrace them with strategies that have high upside potential.

Nassim Nicholas Taleb was the guest speaker at an RBS Insight Event for clients in Milan.

The ex-trader’s warning

Nassim Nicholas Taleb’s 2007 bestseller The Black Swan was hailed by the UK’s Sunday Times as one of the 12 most influential books since World War II.

It looks at the impact of hard to predict, rare events on science, finance and technology. Taleb believes that modern life is so complex these “black swan” events are inevitable.

The book, which sold three million copies worldwide, foresaw the 2008 crisis, criticising the finance industry for structuring itself around models that try to predict extreme events and warning that, if one bank fell, they all would.

Taleb’s follow-up – Antifragile: Things That Gain from Disorder – argues that there are things that not only benefit from chaos but actually need it to survive and flourish. The former Wall Street trader says that, just as human bones get stronger when subject to stress and tension, many things in life benefit from stress, disorder, volatility and turmoil.

Taleb, a former derivatives trader, is currently Distinguished Professor of Risk Engineering at the Polytechnic Institute of New York University.


Disclaimer

No representation, warranty, or assurance of any kind, express or implied, is made as to the accuracy or completeness of the information contained in this document and no member of the RBS Group accepts any obligation to any recipient to update or correct any information contained herein. This document is published for information purposes only and does not constitute an analysis of all potentially material issues. Views expressed herein are not intended to be and should not be viewed as advice or as a recommendation.

You should take independent advice in respect of issues that are of concern to you.

This document does not constitute an offer to buy or sell, nor a solicitation of an offer to buy or sell any investment, nor does it constitute an offer to provide any products or services that is capable of acceptance to form a contract. The products and services described in this document may be provided by any member of the RBS Group, subject to signing appropriate contractual documentation. No member of the RBS Group shall be liable for any direct, indirect, special, incidental, consequential, punitive or exemplary damages, including lost profits arising in any way from the information contained in this communication.

The Royal Bank of Scotland plc (RBS plc) is registered in Scotland No. 90312 with its Registered Office at 36 St Andrew Square, Edinburgh EH2 2YB. It is authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority. The Royal Bank of Scotland N.V. (RBS NV) is registered with the Chamber of Commerce and Industries for Amsterdam, The Netherlands, with No. 33002587; its registered head office is Gustav Mahlerlaan 350, 1082 ME Amsterdam, The Netherlands. It is authorised by De Nederlandsche Bank and is regulated by the Autoriteit Financiele Markten for the conduct of business in The Netherlands. RBS plc is in certain jurisdictions an authorised agent of RBS NV and RBS NV is in certain jurisdictions an authorised agent of RBS plc.

RBS plc or RBS NV is authorised and regulated in Hong Kong by the Hong Kong Monetary Authority, in Singapore by the Monetary Authority of Singapore, in Japan by the Financial Services Agency of Japan, in Australia by the Australian Securities and Investments Commission and the Australian Prudential Regulation Authority ABN 30 101 464 528 (AFS Licence No. 241114) and in the US by the New York Department of Financial Services, the State of Connecticut Department of Banking, the Federal Reserve Bank of Boston and the Board of Governors of the Federal Reserve System. In the United States, securities activities are undertaken by RBS Securities Inc., which is a FINRA/SIPC member and a subsidiary of The Royal Bank of Scotland Group plc.

Copyright 2013 RBS plc. All rights reserved. The daisy device logo, RBS, and The Royal Bank of Scotland are trade marks of RBS plc and the RBS Group Members. This communication is for the use of intended recipients only and the contents may not be reproduced, redistributed, or copied in whole or in part for any purpose without RBS’s prior express consent. Deposits at RBS plc and RBS NV are not insured by the Federal Deposit Insurance Corporation (FDIC) nor by any other governmental agency or body, nor by any other entity, public or private.