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

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

How to Make the Casinos Pay You for a Change

Greg Guenthner

It's a theme we've shared with you since April. And it's only gotten worse. The gaming industry has come under all sorts of pressure--a situation I first noticed in the charts. The powerful, multi-year uptrends started showing cracks. And it wasn't long before those cracks turned into gaping holes you could drive a friggin' truck through. That's where things stand today.


How Low Will Oil Go – And What Can You Do?

Matt Insley

The oil market has been under siege for six months. From service providers to producers this downturn has been painful. Of course, we’ve known all along that oil prices were a little toppy over the summer. In fact, when asked just how low oil prices could go I usually answered with a simple “lower than you’d expect…”


Cuba’s Berlin Wall Moment

Peter Coyne

Our forecast that Cuba would be open and integrated within 5-10 years is on track after yesterday's big announcement. Ahead of schedule, even. Click here to see how some investors have profited and what the island's likely future is...


The $4 LED Trend You Don’t Want to Miss

Chris Mayer

The opportunity to sell and install LEDs is enormous. We’re talking about over a billion lighting fixtures. And the areas with the largest potential -- like parking lots -- have barely begun to change. Banker to the presidents Chris Mayer says you could triple your money in this new tech trend. Here's what you need to know.


Three Time Bombs in Your 401(k) and How to Disarm Them Now

Dave Gonigam

By the time you do… Kaboom! It’s too late. They’ve already blown up your retirement. There are three time bombs the mutual fund industry has planted within your 401(k). By the time you’re done with this article, you’ll know how to identify them. And, more importantly, how to disarm them. Dave Gonigam has the scoop...


Got Tech Stocks? Sell These Flops Now…

Greg Guenthner

The latest victim of the crude rout is none other than the stalwart tech stocks. These are the go-to trades that have held up all year long. I'm talking about stocks like Google, Yahoo! and Microsoft. Like I said before, these aren't no-name stocks you're seeing drop more than 10% from their highs last month.