Mark Spitznagel, whose Universa Investments has built its reputation on protecting portfolios from catastrophic market events, told Business Insider this month that the Mark Spitznagel Kelly criterion framework offers a more practical guide for most investors than tail-hedging alone. Speaking over coffee in London, he argued that failing to take enough risk is itself a serious error, one that can be just as damaging as failing to hedge.
Universa, which Spitznagel founded in 2007 and leads as Founder and Chief Investment Officer, specialises in tail-risk hedging: strategies designed to pay out sharply when markets suffer extreme, low-probability collapses. The firm’s approach drew widespread attention when, as CNBC reported, Universa posted a 4,144% return in the first quarter after the coronavirus outbreak caused a sharp fall in markets. That kind of performance is the logical end-point of what Spitznagel has spent his career building: a structure that absorbs the shock so the rest of a portfolio can remain aggressively positioned.
Why the Kelly criterion matters more than you might think
Yet Spitznagel’s London conversation ranged well beyond his firm’s signature product. He pointed to the Kelly criterion, a mathematical formula for sizing bets so that catastrophic losses become structurally improbable, as the lens through which most people should actually think about their financial lives. ‘It’s more applicable for people to think about their life from a Kelly standpoint, rather than just a tail-hedging standpoint,’ he said.
The Kelly criterion does not counsel timidity. Its logic is about optimal exposure: bet too little and you forgo compounding; bet too much and a single loss can end the game. ‘You can’t let your losses take you out of the game,’ Spitznagel said. Not taking enough risk, he argued, can be the ‘biggest mistake someone makes.’ The prescription is direct: ‘You need to be exposed, you need to bet your beliefs.’
His framing of tail risk follows the same logic. The priority, he said, is ‘mitigating the big losses, not the little ones.’ He illustrated the point with a straightforward arithmetic: an investor who takes a 50% loss on a position must then generate a 100% gain just to break even. ‘It’s not just that it kills you, but it goes down so much, it takes forever to crawl out,’ he said.
Mark Spitznagel Kelly criterion thinking on compounding and AI
Spitznagel and ‘The Black Swan’ author Nassim Taleb began formally managing tail hedges for client portfolios together more than twenty years ago, before Spitznagel established Universa independently. That long collaboration informs his scepticism of certain conventional investment orthodoxies, including the near-universal enthusiasm for compounding.
He cited Warren Buffett’s well-known personal habit of mentally converting every expenditure into its future invested value: in his twenties, Buffett famously felt that a haircut cost him $300,000 in foregone returns. Spitznagel called that mindset a ‘curse,’ because people have finite lives to live alongside their portfolios. ‘What’s the point of compounding if you’re not around to see it?’ he said.
On artificial intelligence, Spitznagel said Universa employs ‘some of the brightest mathematicians and programmers’ on the planet and that they are on the ‘bleeding edge’ of using AI tools. Even so, he maintained that AI will ‘never replace basic human judgement,’ and that ‘there will always be an important place for that.’ He added that he still expects the ‘ability to express yourself and write’ to remain valuable, even as AI takes on more analytical work.
The investment Spitznagel called the best he has ever made sits outside any market. He pointed to his goat farm in Northport, Michigan, describing it as ‘better than anything: yachts, planes, sports teams.’ The farm, he said, satisfies him through ‘making something tangible,’ connects him to his family, and forces him to think in the very long timeframes that define the rest of his professional life. ‘That’s the easiest answer in the world,’ he told Business Insider. ‘It’s not even close.’