In Part I, I examined the concept of hidden asymmetries, as examined by Nassim Taleb in his new book, “Skin in the Game”. In Part II, I will step you through Taleb’s take on another important concept: complex systems. Given Taleb is one of the most highly respected and well-educated mathematicians in the world, when he discusses complex systems it is not a qualitative assessment, but comes from a deeply mathematical, quantitative perspective. We will try and capture the concepts in a simplified analogy.
Let’s start with a small system like a family dinner which has a few participants (let’s call them dimensions). As we increase the number of participants (dimensions) to dinner party size (20 people) then to banquet size (1,000 people) the system become mathematically different and the number of potential interactions between participants increases exponentially (increasing system complexity). Taleb notes that he has seen situations where fractionally small changes in dimensionality have caused mind-numbingly large changes in system complexity that humans are unable to intuitively process. For instance, Taleb writes that going from 1,000 to 1,001 participants in a system (adding 1 participant) can cause complexity to be multiplied by 1,000,000,000 (you read that right, an increase of one participant can lead to one billion times increase in system complexity!).
Now going back to our family dinner à dinner party à banquet analogy, as the system get larger it looks less like individual people interacting and more like a group of people interacting. It is worth noting that the sum of market participants will not explain the behavior of the market. The sum is by definition the average multiplied by a constant, which means all participants are equally affected (which is not true) and “minority rule” impacts will dictate (asymmetries exist, as discussed in Part I). However, humans automatically translate each participant into a constant and multiply when system complexity scales (potentially creating a huge error in what is actually happening and what is being observed). For instance, if someone shouted “fire” in the banquet hall there would be an asymmetrically different impact versus someone shouting “thank you all for coming”, however that type of asymmetry is very difficult to identify as system complexity increases and our mind assumes all participants are the same.
From a markets perspective, as dimensions continue to increase (number of participants, news flow, companies, asset classes, pricing, political events, etc, etc) in this increasingly complex world, system complexity becomes disproportionately difficult to separate between micro and macro. In other words, separating the forest from the trees. At Montaka we have a deep, bottoms up, fundamental, value investing approach to portfolio selection and a thematic / macro overlay to ensure we can identify which forest has the best trees for our investors and we are positioned accordingly to take advantage of them (metaphorically speaking!).
Amit Nath is a Senior Research Analyst with Montaka Global Investments. To learn more about Montaka, please call +612 7202 0100.