Points of Interest – Autumn 2020 Client Investment Update – December 2020

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The Black Swan

This article, by Justin Baiocchi, was originally published in The Northern Daily Leader on 22 April 2017.

In 16th century London, inhabitants used the expression ‘black swan’ to describe something that was impossible. The reasoning behind this was the fact that, up until that time, nobody had ever seen anything but white swans. Black swans were presumed not to exist, so anything that was thought to be impossible was described as a black swan. Then, in 1697, Dutch explorers reached Western Australia and found, to their great surprise, vast numbers of black swans! The impossible really did exist! The expression ‘black swan’ then changed over time to mean an impossibility that was later disproven. For example, the collapse of the Soviet Union seemed an impossibility, until it happened. So, the end of the USSR was a black swan event. The impossible becoming possible.

Black Swan theory was popularised by writer Nassim Nicholas Taleb, who said that black swan events had three defining characteristics: they’re unexpected; they have an extreme impact and finally, we try and rationalise the event after it’s occurrence, as though it was in fact predictable or explainable. In Taleb’s view, events such as the advent of the internet, September 11 and World War 1 were all black swan events. Taleb’s book, ‘Black Swan’, was very popular in finance circles (Taleb himself used to work for investment banks and hedge funds) and forecasting future black swans became a popular pastime for investors and analysts (which sort of defeated the whole point of a black swan event, in that it is entirely unpredictable). Some went so far as advocating investment strategies based on black swans – the aim was to position your investments ahead of a black swan event to either profit from it, or be protected from it. Again, the point was often lost on such advocates, that if you can predict the event in advance, it’s not a black swan event (at least, not in the way it was described by Taleb).

The problem with an investment approach based on predicting the next black swan (such as, putting all your assets into gold, or into cash), is that the black swan you’re waiting for may never arrive. Or a different, but equally unpredictable and severe black swan event may occur, which renders your strategy worthless. For most people, taking all-or-nothing punts on the possibility of a potentially catastrophic outcome, is a bad idea. The idea of a sound and diversified investment approach is not new, but for some people it’s also not exciting enough. When it comes to making (and managing) money however, I’ll take boring over exciting any day.