What is the opposite of fragile? Robust? Wrong!
It’s natural. Most people would often say robust — something that is not fragile, something that does not break. Whilst this common answer may seem correct at first, one can view fragility in a totally different light.
To understand the question better, let us first ask:
What is fragility?
Fragility is used to describe something that easily breaks or is damaged by a stressor/disorder; this means it is a negative response to a stressor.
Meanwhile if something is robust, then it is strong and durable when a stressor/disorder is applied — meaning it is a neutral response to a stressor. Antifragility on the other hand benefits from a stressor/disorder, and hence is a positive response to a stressor.
We can think of fragility, robustness, and antifragility in the following way:
- Fragility is the negative
- Robustness is neutral
- Antifragility is the positive
Another perspective we can think of fragility as being less hurt by small successive events and being hurt more by one single large event.
In Talebs own words,
“Simply, antifragility is defined as a convex response to a stressor or source of harm (for some range of variation), leading to a positive sensitivity to increase in volatility (or variability, stress, dispersion of outcomes, or uncertainty, what is grouped under the designation “disorder cluster”). Likewise fragility is defined as a concave sensitivity to stressors, leading to a negative sensitivity to increase in volatility.” — Taleb, N. N., Philosophy: ‘Antifragility’ as a mathematical idea. Nature, 2013 Feb 28; 494(7438), 430–430
You’re probably still wondering —
What is a stressor?
A stressor can be defined by everything within the set below:
If you possess all of these stressors, then you are in a similar situation to someone owning an option — a financial option, to be precise. Thus, you benefit from optionality. Financial options increase in value when there is an increase in volatility (a stressor). Nevertheless, not all stressors are good. Taleb likes to use the example of falling one meter ten times is good for your bone strength but falling ten meters once isn’t.
How do we benefit from stressors?
To answer this question, we ought to become antifragile. In order to become antifragile we must first become robust. It is a process of identifying fragilities then turning them to a robust form, and finally to antifragilities. Small stressors are good — large stressors are bad, in general. Robustness requires some redundancy. Eg. of robustness is cash in the bank. If that money were to be invested in a certain strategy (that we shall mention) then you’ve successfully turned it into antifragile.
Imagine you have a basement and stock up on say, olive oil. Suppose one day in a black swan event where all of a sudden there is a war and you hide in your basement — jackpot. This is because, while yes, everyday on the balance sheet it looked like a cumulative loss — spending money to hoard/stock up on olive oil. Now however, with the war, you have an inventory of olive oil which will increase in price dramatically! That is an example of antifragility, where we benefited from a random stressor.
The caveat of the ages
People are control freaks. We love to intervene in things that we ought to leave to randomness and mother nature to deal with. By trying to control our environment we tend to remove small stressors rather than the large stressors — thus eliminating small risks and hence leaving the large risks unaccounted for. This is evident in tampering with the economy (treating it like a machine) and also in medicine with the prevalence of the iatrogenic.
Be weary of epiphenomenon. One must understand the directionality of causality, because we can be easily mistaken. A prime example for this is whether education causes wealth or wealth causes education — and by education one means academic institutions.
How to be in a position of antifragility and hence benefit from randomness and volatility?
Simply put,
By systematic trial and error. To be more specific, trial and small error.
Trial with small error = Convex function of randomness
Convexity (the right side of the convex function) will pay you a lot more in the long run than direction (knowing what to do). Basically what this implies is that one does not have to be intelligent, rather one has to set up an antifragile system such that one may benefit from volatility.
If there are only small errors, then there are only small costs. However if gains are large and unlimited then you are positioned properly for a black swan. This is an antifragile system that possesses a positive convexity.
Same goes for financial options. Be as broad as you can with your strategy so you can benefit from the volatility and place yourself in a state of antifragility which will in turn, allow you to benefit from a black swan event.
Another question that you’re probably thinking of is —
What is a black swan event?
Lets bring in a little history. In medieval England, there was a saying that goes something like, ‘you’d sooner find a black swan than blah’. Essentially the equivalent of ‘when pigs fly’. Which basically means it’s not going to happen or that it is impossible. This saying was formed as a result of everyone believing there were only white swans because they never saw a black one. Things however changed, when they discovered there were black swans in Australia.
This anecdote sheds light on an important issue which Taleb mentions repeatedly in his book ‘Antifragile: Things That Gain from Disorder (Incerto)’*, that the absence of evidence is not evidence of absence.
With that in mind we can then go on to the definition of what a black swan event is.
An event is a black swan if it fulfills these three requirements:
- it is an outlier/unpredictable
- it is has an extreme impact
- its is only explainable after its occurance
eg. world war one, Black Monday, world religions
N.b.#1 The corona virus crisis is NOT a black swan event. Look at the three requirements and ponder why.
Here we run into a problem:
How can we predict the future which is infinite and unknown with something finite and known (historical data)? Aha.. this means that we’re practicalluy blind to black swans.
Okay, so there is a black swan.. we know there is white swan. How about a grey swan? What is the difference between them?
N.b. #2 The corona virus crisis seems to be a white swan event, No?
Implications of black swan blindness
There is a fairly long list of implications that result from our inevitable black swan blindness — and they are:
- the error of confirmation
- the narrative fallacy (stories stick, statistics do not)
- we are not programmed for black swans
- Tunneling (we only go to what we know, not what we dont know)
- mediocristan vs extremistan (for mediocristan: when your sample size is large, no single instance will significantly change the aggregate or the total; for extremistan (eg. financial markets)). can predict mediocristan, cant predict extremistan
- Gaussian Schmaussian, (normal distribution is used commonly in risk management) apply only for variables in mediocristan not extremistan. Instead, we can use mandelbrotian randomness (does not assume deviations from the mean becomes increasingly difficult) it allows us to turn black swans into grey swans (these are the known unknowns)
Once we’ve understood antifragility, types of stressors, and black swans and their implications — we can finally begin to question, as investors, how can we utilize this knowledge in our portfolios?
How to act as an investor in an environment with black swans
Taleb advocates for two primary approaches for investors to benefit from black swans, they are namely:
1- The hyper-conservative and hyper-aggressive approach:
The ultimate intitially counter-intuitivee rule for this approach is not to put your money in “medium risk” investments. Put 90% in a very safe investment eg. T-Bills. The remaining 10% should be allocated to extremely speculative investments such as options. This is called the convex combination. Nassim also calls it “The barbell strategy”.
2- The speculative insured portfolio:
This is a very clever approach — that may not be easy to execute. Get a very speculative portfolio but insure it for losses greater than 50%. Might not be always possible. (Instead of using insurance companies, you can also use a stop-loss strategy to simulate this). This strategy is also a convex one. Unlimited gain. Minimized risk.
Five interesting quotes by Taleb
Finally, I’d like to leave you with two things; five interesting quotes by Taleb and a recommendation to read his book ‘Antifragile: Things That Gain from Disorder (Incerto)’*:
“The fool generalizes the particular; the nerd particularizes the general; some do both; and the wise does neither.” — Nassim Nicholas Taleb in The Bed of Procrustes
“Best training ever for rigor & critical reasoning is…TRADING. You can ONLY survive long term by going against wrong CONSENSUS by “experts”” — Nassim Taleb
“We see the obvious and visible consequences, not the invisible and less obvious ones. Yet those unseen consequences.., generally are more meaningful.” — Nassim Nicholas Taleb in The Black Swan
“They think that intelligence is about noticing things that are relevant (detecting patterns); in a complex world, intelligence consists in ignoring things that are irrelevant (avoiding false patterns).” — Nassim Nicholas Taleb in The Bed of Procrustes
“This is the central illusion in life: that randomness is risky, that it is a bad thing and that eliminating randomness is done by eliminating randomness.” — Nassim Nicholas Taleb in Antifragile
In the coming articles, I intend on exploring the fat tails, and Talebs’ take on them.