How A Goat Farmer Built A Doomsday Machine That Just Booked A 4,144% Return

Mark Spitznagel’s $4.3 billion Universa Investments has waited 12 years for a perfect catastrophe.

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^It’s early April and from his farm perched atop a hill on the edge of Lake Michigan, hedge fund investor Mark Spitznagel is dodging the coronavirus in a setting reminiscent of a Winslow Homer painting–and relishing one of Wall Street’s greatest investing coups.

Spitznagel’s Idyll Farms on Michigan’s Grand Traverse Bay will soon be home to 400 newborn alpine goats that will graze on 200 acres of rolling pasture, fattening up to produce cheese that will be flavored with herbs and honey. “We are as vertically-integrated as we can possibly be,” says Spitznagel of the naturally replenishing abode. When he’s not herding goats, Spitznagel, 49, plays in the wildest corners of financial markets, where he’s an expert in trades that carry deceptive risks.

Spitznagel’s $4.3 billion (assets) firm Universa Investments and his team of about a dozen PhD’s, mathematicians and trading experts earn their money by making trades that nearly always lose small sums–but very rarely generate astronomical payouts. Universa buys short-term options contracts that protect against a spike in volatility, or a plunge in markets, which are highly “convex" and “out-of-the money." In plain English that means it would take a sudden, major crash for the trades to pay off. Every trading day, investors around the world make a little easy money by selling Spitznagel options.

Until one day–maybe only every five or ten years–a black swan appears, terrorists ram jets into skyscrapers or a global pandemic freezes the global economy. Then the tables turn hard and Spitznagel makes an enormous amount of money, more than enough to make up for all those many days of small losses. And those caught feeding on Spitznagel’s bait find themselves trapped in a trade that carries almost unfathomable losses. Sometimes they’re wiped out entirely.

Take March, a month in which the S&P 500 Index cratered nearly 30% at its lows, shedding trillions in market value. Spitznagel had bought puts—or the right to sell the index at a specified price—well below the prevailing market price, and the firm had its best month ever. 

Universa’s flagship “Black Swan Protection Protocol” fund earned its near two dozen institutional investors a staggering 3,612% in March, putting its 2020 gains at 4,144%. From his remote farm, on April 7, Spitznagel fires off an update to his investors that is soon read worldwide. “These returns likely surpass any other investment that you can think of over the period you have been invested with us,” he crowed. “Kudos to you for such a sound “tactical” allocation to Universa.” 

Spitznagel has built a career feasting on traders’ greed—prioritizing quick gains over prudent risk taking. To earn these easy gains, traders readily assume “tail risks” or huge but extremely remote potential losses. Eventually, someone gets caught. When a financial panic, or an unexpected event like the coronavirus surfaces, Spitznagel’s firm converts from what once looked like a charity into a financial powerhouse that’s fully stocked with valuable hedges. Then Spitznagel caters to traders' new immediate demand, which is fear.

“We exploit properties in markets that take years and years, and even decades, to show themselves,” he says. At the pivotal moment of crisis, his trades, which cost almost nothing to put on during good times, can be sold at almost infinite prices. "Liquidity is really about the price for immediacy and we are capturing that on both sides of our trade,” Spitznagel philosophizes.

In the case of March, Forbes estimates that Spitznagel’s protection trades cost under $100 million to put on and yielded at least $3 billion for Universa’s clients, which could be plowed into cratering markets, or stored under a mattress. The fine print of Universa’s public filings shows it protects portfolios worth $4.3 billion, but on any given day its actual capital at work is as little as 2%-or-3% of that figure. It's why no new “trillionaires” were minted in March.

Universa’s 4,144% payout cost its investors about 1% annually due to Universa’s hefty “2 and 20” hedge fund fees, per Forbes analysis of public filings. After the March payday, its flagship Black Swan fund has produced a mean annual return on invested capital of 76%* since the firm was created in 2008. It’s a good result, but if you were going to make the same calculation as of Dec. 31 2019, the long-term compounded return would only be marginally better than that of the S&P 500 over the same time period. Moreover, the "forces of good" in the market, like the Federal Reserve Bank, are now trying to foil Spitznagel’s bread-and-butter trade.

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Raised in Northport, Michigan where his father was a protestant minister, Spitznagel’s big break came as a 16-year old when he visited the Chicago Board of Trade to meet a family friend named Everett Klipp, who ran a futures trading firm. He was mesmerized by the “unmistakable, intricate communication and synchronism” of markets and began to obsess over grain prices and crop reports as a clerk for Klipp during summers away from school.

Klipp forged in the impressionable Spitznagel the virtues of booking small losses. “I used to come to Everett with stacks of research on corn crops. He’d laugh at me and say it was all crap,” Spitznagel remembers, “All that matters is you’ve got to take your small losses.” Watching a steady stream of traders get wiped out by margin calls—like in the final scene of the 1980s classic film Trading Places—only reinforced the point.

At 22, after graduating from Michigan’s Kalamazoo College in 1993, Spitznagel bought a seat at the CBOT and traded treasury bond futures and euro-dollar futures. The chaotic, unruly venue was the frontlines of open outcry capitalism and a delight to the libertarian leaning Spitznagel. To this day, he works in an office with his pit trading outfit, a “bloodstained” aqua-blue jacket and an Adam Smith necktie, framed on the wall.

A big test came in 1994, when the Federal Reserve unexpectedly raised interest rates, causing treasury markets to plunge, wiping out many traders. “What it did to guys that were kind of my trading heroes was definitely foundational for me,” Spitznagel recalls. He survived because of Klipp’s teachings. “Look like a jerk, feel like a jerk,” says Spitznagel of his comfort with small losses, “Look like an ass, feel like an ass.”

He then moved to the trading arm of a Japanese bank just in time to witness the 1997 Asian financial crisis and the default of Russia, which caused the Nobel laureate backed hedge fund, Long Term Capital Management, to lose $4.6 billion and collapse. This convinced Spitznagel to hone an investing style that would profit from panics. In 1999, Spitznagel matriculated to NYU’s Courant Institute for mathematical sciences, studying under “Black Swan” theorist Nassim Taleb. That year, they launched a hedge fund called Empirica, which aimed to profit from unexpected “fat tail” financial events. The fund was disbanded in 2005, and after a two-year stint at Morgan Stanley, Spitznagel created Universa months before the 2008 financial crisis.

Universa returned 115% in 2008 and Spitznagel used proceeds from his coup to buy a Bel-Air mansion from singer Jennifer Lopez a block from the home of his hero Ronald Reagan. Five years later, Spitznagel published The Dao of Capital, a dense 368-page libertarian economic treatise that lambasted central banks for the crisis. Unlike most bears who try to time bubbles, Spitznagel’s playbook is different. No matter the circumstance, he’s always giving away free pennies to the market in order to maintain an arsenal of bearish bets that could be worth thousands of times their cost if markets go haywire. 

Despite his grouchy demeanor—“When people think that markets are cheap right now, they are just kidding themselves. I mean absolutely kidding themselves!”—Spitznagel’s mathematical view of the world is in some ways similar to capitalism’s ultimate optimist, Warren Buffett. His selling of immediate gratification for a massive payday far down the road, after all, is engineered to conjure cash and profit, in crashes. In an inverse way, this is not unlike how Buffett accumulates cash from small insurance premiums over long periods, building dry powder, that he then uses to pounce on bargain buys. Spitznagel calls his trading mousetrap a “thing-a-ma-jigger" harpoon, based on the Dr. Seuss classic McElligot’s Pool, whereas Buffett is famous for aiming his “elephant guns” when deals abound. He’s also a proselytizer of compound returns: “The big losses are essentially ALL that matter to your rate of compounding,” says Spitznagel.

Besides 2008, Universa’s doomsday machine kicked in during the 2011 crisis created by the downgrade of the U.S. government’s debt, and the August 2015 crash of the Chinese market. Likewise during the downturn of late 2017 and early 2018, Universa took advantage of the so-called “volmageddons” or surging volatility that caused the market drop. Now comes the mother of all black swans, the coronavirus pandemic of 2020, which has seen stock markets plummet globally in a matter of weeks.

As the majority owner of Universa, Forbes estimates Spitznagel’s net worth is now $250 million, and more than a few in the media and on Wall Street have taken notice. Will Spitznagel’s lucrative “moat” get arbitraged away? "It should,” he says, “But do I lose any sleep over it? Not a minute... There’s such a herd mentality in finance.”

Spitznagel is also unconcerned about the Fed’s save-the-market-and-economy at all costs approach, given that it has already pumped $6 trillion of dollars into a host of different securities markets.

Says Spitznagel with the cocky assuredness of poker pro,“There is a limit to sovereign debt and there is a limit to central bank balance sheets... When I thank the central bankers of the world for my business, I’m not kidding.”

*Updates description of annual returns