Grey what ?

Some of you might be asking this question, concerned that you’ve stumbled onto some really weird bird watching website. Well, don’t worry. This website might yet be weird, but it’s definitely not about bird watching.

Some time ago, I read a book that you might be familiar with, “The Black Swan” by Nassim Nicholas Taleb. The gist of the book is this: that in life, and particularly in the finance world, we as individuals are beholden to impactful & unpredictable events. While we often think we can predict what will happen, we are simply bad at predicting, or we characterize our predictions incorrectly. The net effect is that we, believing we can predict outcomes, get blindsided by what we can’t see, can’t understand, or just don’t understand properly.

These unanticipated events are “Black Swans”. The title refers to the fact that at the turn of the century, people believed all swans were white because no one had seen a non-white swan. The fact that a breed of black swan was eventually discovered highlights the fact that if one has never experienced something before, it doesn’t mean it can’t happen.

Having managed my own investment portfolio since the late 90’s, this struck a chord with me. I had seen a lot of “seismic” moves in the market, many of which seemed to take everyone (even the experts) by surprise. However, the fact that they occurred more often than the “expert models” predicted suggested that they might actually be…a bit predictable. So while I fully admit that I can’t predict exactly when something might happen, or what might happen, I do know that I can expect an unusually large market event more often than not. Sometimes it’s the entire market, such as the Financial crisis, or sometimes it’s one small company that comes out of nowhere. Either way, to use a cliché, I’ve come to expect the unexpected.

So, if a Black swan is no longer unexpected, it’s been suggested that it’s actually a Grey swan – an impactful event that you know will show up at some time, but you’re not sure exactly when. It’s these events that have shaped a large part of my life (good and bad), and the occurrence of which I now try to remind myself of. On the bad side of the ledger, I’ve come to expect significant negative market moves, so I try to keep a large part of my portfolio as “low risk” as I can tolerate. On the other hand, I have also seen very small companies that finally achieve market recognition – and proceed to move upward, sometimes in the 1000’s of percentage points. The world of my personal finances has definitely been the victim (and beneficiary) of more than a few swans. Whether they are Black or Grey – I’m not entirely certain.

So that’s the story behind the “Grey Swan” concept. Having embraced this concept, a lot of my money sits in what Taleb calls “Mediocristan”, a place where returns are lower, but are largely sheltered from potentially unforeseen events. A smaller part of my portfolio exists in “Extremistan”, where there is more risk – but the returns of one position can often eclipse that of all the other losing positions I might have. Being a bit of a “grey bird” myself, I’ve come to the conclusion that while I’ll never be smart enough to anticipate the Black or Grey swans out there, I might as well harness a few while I can!