Chris Mayer

The Hydra of Greek myth is a many-headed serpent with a bad temper. But it has a special ability that makes it very hard to kill. When you cut off one head, two grow back in its place.

To author Nassim Nicholas Taleb, the Hydra is the perfect metaphor for “antifragility.” The awkward and invented word is the title of his latest book, subtitled Things That Gain From Disorder.

It is a simple enough concept, but it is rich in application.

As an investor, antifragility captures an idea that I think will be more important in our crisis-filled times. In short, you want to own some Hydras in your portfolio.

Let us start with this aspect of the idea: You can’t predict when or what the next shock will be. (Unless you enjoy deceiving yourself, as Taleb points out.) But you can “state with a lot more confidence that an object or a structure is more fragile than another, should a certain event happen.”

For example, you can state with confidence that a porcelain vase is more fragile than a steel pot if dropped. You can look at one building and deduce it will withstand an earthquake better than another. And you can compare stocks and say which is more likely to survive a crisis.

While reading the book, I kept thinking of companies I like that exhibit traits of antifragility. Like banks that did not suffer in the financial crisis, but used the opportunity to buy failed banks for cheap. Or like real estate companies that find deals in distressed assets. I also thought of reinsurance as an example of a great antifragile business.

Then, on Page 73 of Taleb’s book, I read:

“Some businesses love their own mistakes. Reinsurance companies, who focus on insuring catastrophic risks (and are used by insurance companies to ‘reinsure’ such nondiversifiable risks), manage to do well after a calamity or tail event causes them to take a hit. If they are still in business and ‘have their powder dry’ (few manage to have plans for such contingency), they make it up by disproportionately raising premia…”

All the reinsurer has to do is keep mistakes small and maintain a nice cushion? Such a reinsurer has awesome antifragile properties.

I picked up on a similar theme in the June 1993 issue of Schiff’s Insurance Observer in a piece titled “Smoking TNT and Drinking Dynamite: It’s Business as Usual in the Insurance Industry.”

Insurance is one of those quirky industries for which bad news is good news, a point we should keep in mind as insurers take their beating from Hurricane Sandy. As Schiff writes, “Earthquakes, hailstorms, explosions, blizzards, tornadoes and tropical storms are considered augurs of better times to come.”

The theory is that as insurers take their lumps, there is less insurance capital around. Less capital around means higher prices for insurance. In this way, insurers make up the losses and then some. It doesn’t always work out that way, of course, but often seems to.

Point being, reinsurance would seem a rare industry that gains from disorder. It is a Hydra. Hydras, though, don’t dwell only in certain industries. There are characteristics that cut across industries. I can’t do justice to the many ideas in Taleb’s book here, but I want to highlight one.

“Skin in the Game” is a chapter in Taleb’s book. Simply put, if you want antifragility, it helps to have insiders with money on the line. No upside for anyone without downside. No freebooting CEOs with golden parachutes when they fail. No wonder, then, “there seems to be a survival advantage to small or medium-sized owner-operated or family-owned companies… There is a difference between a manager running a company that is not his own and an owner-operated business.” The latter has downside.

Clearly, most of the stock market does not operate on this principle. Instead, most corporate “suits” have “incentives” but minimal ownership. They get a free ride at the shareholders’ expense.

Taleb uses the example of Robert Rubin, who made $120 million in a decade at Citibank. Citibank collapsed, but Rubin kept his money. Shareholders lost. (And taxpayers, too, unfortunately.) This aspect of modern markets really irritates me. I get grumpier about it as I get older. I’m at risk of becoming a curmudgeon.

Fortunately, as fragile as much of the market and its corporations may be, there are always exceptions. I want to own the exceptions. And some of these even profit from this world of disorder. Which reminds me of another metaphor I thought of for antifragility: the fictional private detective Philip Marlowe. In one of Raymond Chandler’s short stories, Marlowe says: “Trouble is my business. How else would I make a nickel?”

Regards,

Chris Mayer
for The Daily Reckoning

You May Also Like:


Super-Antifragilistic

Dan Denning

The trouble with today’s financial system is that the authorities are trying to de-risk it, suckering everyone into behaving recklessly.

Chris Mayer

Chris Mayer is managing editor of the Capital and Crisis and Mayer's Special Situations newsletters. Graduating magna cum laude with a degree in finance and an MBA from the University of Maryland, he began his business career as a corporate banker. Mayer left the banking industry after ten years and signed on with Agora Financial. His book, Invest Like a Dealmaker, Secrets of a Former Banking Insider, documents his ability to analyze macro issues and micro investment opportunities to produce an exceptional long-term track record of winning ideas. In April 2012, Chris released his newest book World Right Side Up: Investing Across Six Continents

Recent Articles

Modern Monetary Theory (MMT): How Fiat Money Works

Chris Mayer

From time to time, the curious economist in you may wonder, "How does a fiat currency system actually function?" and, further, "Why don't more countries default on their debt?" Well, it turns out there as a nifty little theory that explains exactly why these things happen. And the answers may surprise you. Chris Mayer explains...


Bill Bonner
The Surprising Reason QE Lives On

Bill Bonner

QE3 officially came to an end today, with the Fed stopping its $15 billion monthly bond purchases. But what does that mean for the US economy going forward? Today, Bill Bonner explores that question, and why you probably haven't seen the last of QE just yet. Read on...


Video
Why Lower Gas Prices Are NOT “Bullish Indicators”

James Rickards

As U.S. gas prices continue to head lower, U.S. consumers are getting a little bonus to their disposable income. Some economists like to tout this as a "bullish indicator" for the overall economy. But as Jim Rickards explains in this interview with RT's Erin Ade, nothing could be further from the truth...


Extra!
Why You Need to Pay Attention to the Swiss Gold Initiative

Grant Williams

The Swiss Gold Referendum is set to take place on Nov. 30, 2014 - just six weeks away. And depending on how the vote turns out, the world could wake up on Dec. 1 with a very different outlook for the rest of the year... and beyond. In fact, it could be one event that helps trigger a major financial collapse. Grant Williams explains...


Amazon Is A Big, Fat “Sell” – Here’s Why…

Greg Guenthner

Just one short year ago, investors were rejoicing at Amazon's huge bounce. But thanks to a blundered foray into the smartphone market and a drone delivery service that never materialized, Amazon has had a fairly rocky 2014. Today, Greg Guenthner explains why this stock is a sell, AHEAD of the holiday season. Read on...