How many Black Swans can your portfolio handle? USD collapse? Gold, Bitcoin, Equity?

This US election season is filled with uncertainty. Uncertainty not just political, but also of health, social structures, and most definitely of money.

Together with the fact that this coincides with the end of the long term debt cycle and at a time when China is aggressive, powerful, and engaged in conflict with the US makes it a situation where the best of the portfolio managers in the world are left pondering on what is the best course to safeguard oneself.

Buffet shorted the banks and bought Mining companies and is sitting on huge cash. He historically loved Banks, compounding assets, and disliked Gold. Why would he do everything that is atypical unless he is pushed to a corner to do nothing but that? Why would he do so unlike the euphoric Call option buyers on Robin Hood every morning, unless he sees something quite different?

Ray Dalio has diversified into China and Gold heavily. His new book goes to great lengths to analyze and document cycles of power transfer in the world and he has clearly positioned himself in the direction of his views even though that has cost his fund, performance this year — The fund lost due to market downturn in March and he didn’t get back in soon enough. He is the most successful Hedge fund manager in history. Why would he risk underperformance and loss of his AUM?

No one is immune from a tail event, if and when it happens. You might think I have Treasury bonds, I’m safe. You might think I have all cash in Checking accounts, I’m safe or you might think I have gold in a vault I’m safe, or even that I have Bitcoin in cold storage and I’m positioned rightly. You might be right, but as I will argue below, even if you are right, you might end up in a bad position overall and even if it ends up all well there will come a testing situation and trying time when your conviction will be put to test and unless you have your whole situation worked out well in advance in a wide variety of different use cases, the testing times can get out of you — an action that will eventually in hindsight prove to be terrible.

Let me explain with a couple of examples what I mean -

Example 1 — If you have USD in Checking account and nothing actually happens to it, but that due to tremendous inflation, using the same amount you can barely buy anything, what’s the point?

Example 2 — If you have everything in Bitcoin and even its value goes parabolic, but you are prevented from withdrawing it into your currency to use for yourself, what will you do?

Example 3 — You have all Bitcoin and there is sudden news that the Govt will make it illegal to hold from tomorrow and it falls by 50%, at which point you will be forced to liquidate, but that news will turn out to be fake, and Bitcoin appreciates 200% the following day.

Because of the high volatility and high uncertainty, the universe of possible outcomes non-linearly increases and the best of the fund manager’s skills can turn out to be quite inadequate. And the current financial system is anything but a simpleton for us to just be focussed on the number, as measured in USD.

In this post and a few that follow it, I try to reason aloud, if you are someone who is managing and overseeing some assets — personal, family, or pooled, how best to think through the situation and position yourself for least hurt, least damage and most importantly the least heartburn.

First, we address the elephant in the room: What if all of this is wrong and nothing changes, and then I compile a wide variety of possibilities, that a lot of people have reasoned out could transpire.

Next, in subsequent posts, I will take a look at how one can craft a portfolio that can in most of these possible outcomes be better off.

In those instances which are in line with what you believe could transpire, one ought to stand to gain much more; but yet in many other unlikely outcomes, the portfolio shouldn’t lose much. How do you construct such a portfolio That’s the art of Portfolio Construction, in my humble opinion?

Join me in this series as we discuss and build such a Black Swan proof portfolio, yet benefiting in most possible outcomes, specifically in those that we believe are likely.