As a kid, one of the most fascinating thing I ever witnessed while conducting my own zoology experiments, was to watch a lizard leave it’s tail behind.
I am sure many of you must have found it intriguing that a lizard, if threatened, can voluntarily let go of its tail. It’s common in many lizard species to shed a part of their tails. It’s a survival mechanism. The trick allows these reptiles to escape when captured by the tail by a predator. The detached tail writhes and wiggles, creating a deceptive sense of continued struggle, distracting the predator’s attention from the fleeing prey animal.
It’s a marvellous self-preservation mechanism that evolution has given to lizards. And what’s more fascinating is that the lizard can grow that tail back in a matter of few weeks. What a robust way to deal with loss!
If that sounds cool then you must also know about Hydra. It is a serpent-like creature from Greek mythology. Hydra grows two new heads every time you cut one off. In Indian mythology, there is a similar character called Raktavija. A demon (asura) who who has the magic boon that every drop of blood shed from his body gives rise to another Raktavija (literally the blood borne).
These apocryphal characters are very important metaphors to improve our understanding about fragility and robustness.
What is fragile? Something which breaks or disintegrates easily when subjected to a stress or disorder. Isn’t it?
Now if I ask you what’s the opposite of fragile, you might say – ‘Robust’ or ‘Resilient’. These are the words that came to my mind when I tried to answer this for the first time.
But think about it for a moment. Is ‘staying same’ the opposite of the word ‘decrease’? Because that’s what robust or resilient means – something which doesn’t break, i.e. stays the same when subjected to stress. Right?
Just like opposite of ‘decrement’ is not ‘staying the same’, opposite of fragile cannot be ‘robust’. So Nassim Taleb has coined a new word for things which are opposite of fragile. He calls it Antifragile. These are the things that benefit from shocks; they thrive and grow when exposed to volatility, randomness, obstacles, disorder, unexpected events, change, and stressors.
Being resilient or robust means that you bounce back quickly from disturbances . For example, a bridge that can withstand a 9.0 earthquake.
Antifragility describes things that not only bounce back quickly, but come back stronger when they meet adversity. Antifragility is beyond resilience or robustness. The resilient resists shocks and stays the same; the antifragile gets better. A lizard is robust but a Hydra is antifragile.
Antifragility in Nature
If antifragility looks to you like an academic concept with no real world application then let me take a non-mythological example.
When you exercise or lift heavy weights, it exerts stress on your body. As a result muscle fibres break down but how does the body respond to this strain? Those muscle fibres don’t just repair themselves back. They actually grow back much stronger. The body’s response is to overcompensate to the trauma and come out stronger than before. This process of overreaction to stress and harm is how mother nature operates. It is the process of life itself. Human body is antifragile.
And not just muscles, our bones too grow stronger when subjected to moderate stress. Now the reverse holds true as well: Remove stress from a system, and that system grows weak. Stay in bed for three weeks instead of lifting weights, and muscles atrophy. Bones, in absence of stress, become weak and wither away. So an antifragile body doesn’t just thrive on stress but it needs the stress to flourish.
For that matter, most organic entities are intrinsically antifragile, while artificial creations are at best robust and likely fragile. Most of the man made things especially mechanical ones are subject to wear and tear and horribly fragile in long term. So my laptop isn’t growing stronger as I am hammering my fingers on the keyboard. Laptop is, thus, fragile or at best robust, if it lasts forever.
It’s worth noting that things are antifragile up to a certain level of stress. Even our so called antifragile body benefits from some amount of mishandling, but up to a point. We would not benefit too much from being thrown down from the Eiffel tower.
What implication does this idea have for an investor?
Of course you want to introduce the element of antifragility in your finances. And the first step is to remove the fragility. How do you do that?
Get rid of debt. Debt not only takes away the safety, it actually makes your finances extremely fragile in the face of unexpected adversity. It is the opposite of redundancy. Taleb writes –
When you don’t have debt you don’t care about your reputation in economic circles – and somehow it is only when you don’t care about your reputation that you tend to have a good one.
Any sensible personal finance advisor would recommend you to first get rid of personal debt and create an emergency fund. This will make sure that you don’t get wiped out in the face emergency and have sufficient cushion to build your financial strength again. In fact, availability of cash during crisis lets you exploit the opportunities and grow stronger.
The next most important question that an investor can ask is – are there any antifragile businesses? If yes and if they are available at reasonable price, you’ve got a jackpot. So what does an antifragile business look like?
Taleb explains –
Some businesses love their own mistakes. Reinsurance companies who focus on insuring catastrophic risks (and are used by insurance companies to “re-insure” such non-diversifiable risks), manage to do well after a calamity or tail event that causes them to take a hit. If they are still in business and “have their powder dry” (few manage to have plans for such contingency), they make it up by disproportionately raising premia – customers overreact and pay up for insurance. They claim to have no idea about fair value, that is, proper pricing, for reinsurance, but they certainly know that it is overpriced at times of stress, which is sufficient to them to make a long term shekel. All they need is to keep their mistakes small enough so they can survive them.
Warren Buffett probably understood this and that’s why he refused to participate in the race for mindless growth for his insurance subsidiaries. A relentless focus on underwriting profitability made sure that he had his “powder dry” when other fragile competitors would routinely get wiped out in the event of one bad year.
Berkshire’s great managers, premier financial strength and a variety of business models protected by wide moats amount to something unique in the insurance world, writes Buffett, “This assemblage of strengths is a huge asset for Berkshire shareholders that will only get more valuable with time.”
All economic moats are either widening or narrowing and for an antifragile business, the moat is always widening even though you can’t see it in short term. Buffett’s Berkshire is the greatest example of an antifragile business.
In the context of antifragility, Taleb gives a great analogy between forest fire and economy. He writes –
Small forest fires periodically cleanse the system of the most flammable material, so this does not have the opportunity to accumulate. Systematically preventing forest fires from taking place “to be safe” makes the big one much worse. For similar reasons, stability is not good for the economy: firms become very weak during long periods of steady prosperity devoid of setbacks, and hidden vulnerabilities accumulate silently under the surface – so delaying crisis is not a very good idea. Likewise, absence of fluctuations in the market causes hidden risks to accumulate with impunity. The longer one goes without a trauma, the worse the damage when commotion occurs.
Come to think of it, the stock markets do exhibit the characteristics of antifragility. In markets, paradoxically, there is no long-term stability without short-term volatility.
Detecting the Fragility
To build antifragility you need to first understand the characteristics of fragile systems. How do you know if you’re dealing with a fragile system?
Fragile systems experience increasingly bigger harms as the size of the stress increases. To describe the idea in Taleb’s words –
The difference between a thousand pebbles and a large stone of equivalent weight is a potent illustration of how fragility stems from non-linear effects…so if you double the dose, you get lot more or a lot less than double the effect – if I throw at someone’s head a ten-pound stone, it will cause more than twice the harm of a five-pound stone, more than five times the harm of a one-pound stone, etc…Jumping from a height of thirty feet brings more than ten times the harm of jumping from a height of three feet.
This nonlinear characteristic of fragility is also referred as negative convexity. Antifragile systems are opposite, i.e. they exhibit positive convexity. In a linear system, you have to be right 50 percent of the times to be average however it’s not so in case of non-linear payoffs.
The hidden benefit of antifragility is that you can guess worse than random and still end up outperforming…this explains my statement that you can be dumb and antifragile and still do very well.
That’s why you don’t need to pick hundreds of great stocks in your investing life to do well. All you need is few good ideas and they can take care of everything. I can personally vouch for this. In my own portfolio, in last 6 years, more than 50% of the profits have come from a single stock.
Taleb summarizes –
If you have favorable asymmetries, or positive convexity, options being a special case, then in the long run you will do reasonably well, outperforming the average in the presence of uncertainty.
Wind extinguishes a candle and energizes fire, writes Taleb, “Likewise with randomness, uncertainty, chaos: you want to use them, not hide from them. You want to be the fire and wish for the wind.”
Recall the fundamental notion behind antifragility: the antifragile benefits from volatility and disorder, the fragile is harmed. Well, ‘time’ is the same as disorder.
“Time has sharp teeth that destroy everything,” declaimed the sixth-century poet Simonides.
But if something survives the ravages of time, it probably has some antifragility into it. A business which has survived few market cycles (10 years) has better odds of being antifragile than the one which has been around only for past few years. Taleb argues –
What survives must be good at saving some (mostly hidden) purpose that time can see but our eyes and logical faculties can’t capture.
So if you, or for that matter any business, can make time an ally, it will serve well. Think on the scale of months and years and decades (not hours, days, weeks). The lesson here is that being a Hydra is all about the long term.
Remember what Buffett once said –
Time is the friend of the wonderful company, the enemy of the mediocre.
Take care and keep learning.