The world of asymmetries and complex systems (Part I)

I recently finished reading Nasim Taleb’s latest book, “Skin in the Game” and thought it would be useful to share some of our insights from it in the context of our investment process here at Montaka. As we know, Nassim Taleb is famous for many groundbreaking contributions to financial markets including his seminal work “Fooled by Randomness” and most famously “The Black Swan”. In his latest piece, Taleb focuses on asymmetries and sharing of risk and reward. He highlights that the division of these fundamental tenants of markets (risk / reward) are often imbalanced between participants, creating non linearities and divergences which can produce a mind boggling order of magnitude effects.  At Montaka, we are constantly on the lookout for these types of hidden asymmetries to take advantage of on behalf of our investors, in both our long and short portfolios.

An interesting framework explored by Taleb is the “minority rule”, which he calls the “mother of all asymmetries”. It presents the notion that the world (and the financial market) is not driven by majority consensus, but by a small, stubborn minority. For example, he looks at halal meat in society and notes that only 3-4% of the population care whether meat is halal or not (usually for religious reasons). However, when looking at the presence of halal meat in these same markets, it can be as high as ~70%. So why does a 3-4% minority cause 70% of the population to do things differently rather than being forced to change themselves?  The reason is a stubborn minority (in this case driven by religion), can impose its will on a relatively disinterested majority (unlikely to care or notice if they are eating Halal or not).

Extending this concept to financial markets, Taleb notes that price movements are NOT the sum of market participants, but the activity reflected by the desire of the most motivated buyer and most motivated seller. For instance, in January 2008, the value of equity markets was ~$30 trillion, however a single sell-order worth $50 billion, less than 0.2% of total market value triggered a ~$3 trillion (~10%) drop.  The “sell order” came at the directive of senior management at the French bank Societe Generale, once they discovered unauthorized trading positions established by a rogue trader (Jérôme Kerviel) and hence became the “stubborn minority”. Looking at markets more generally, as the role of passive investing becomes more widespread, perhaps we should be asking whether that passive capital is becoming the disinterested majority and to open to an asymmetric shock that active managers like Montaka (stubborn minority) may be more attuned to identifying.

Amit Nath is a Senior Research Analyst with Montaka Global Investments. To learn more about Montaka, please call +612 7202 0100.

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