The Black Swan (Second Edition)

4 out of 5 stars.

by Nassim Nicholas Taleb, Penguin 2010, $29.95

If you are not familiar with Taleb’s work, the central theme is simple: we don’t know what we don’t know.

All swans were considered white for a few thousand years before black ones were discovered in Western Australia in the 18^th century. That’s the analogy behind the title.

The first edition firmly placed the term in the risk analysis lexicon. In this second edition, a 70 page addendum looks at what we can do about unpredictable events.

It’s still a book of mixed emotions. The practical suggestions are a touch disappointing compared with the robust, and at times uplifting, critique of modern risk analysis.

Most experts, says Taleb, are seduced by the norms of the bell curve to live in what he terms Mediocristan – an intellectual space in which we are blind to the silent evidence of the serious game changers that come from the highly improbable. They only exist in Extremistan.

There is plenty of evidence. Empirical studies of the predictions of “experts” in any field – particularly investment and economics – show them to be highly unreliable.

We have all witnessed this. I once ran an annual competition at our client Christmas party where we asked highly qualified investment analysts to choose two stocks – one by throwing a dart at a page in the Wall Street Journal and another based on their investment preferences.

A year later, the dartboard was invariably ahead.

Taleb’s example is the humble turkey. Having been graciously fed for several years by allegedly supportive humans, those same handlers violently end the turkey’s life just prior to Thanksgiving or Christmas.

The turkey sees no evidence of such a Black Swan event until the guillotine finally falls. Taleb puts most experts in the same corner.

There is no sanctuary in this book for those who practice probability theory. The idea of chance is equally constrained by available evidence.

The author calls this the “Ludic Fallacy” in which people see gambling as a game of chance in which Black Swan’s are accommodated.

No, says the author. The arithmetic of the casino is clear to anyone who does the numbers on the house take and the odds in the game being played. No Black Swans there. The outcomes are predictable.

Not so when it comes to wars, unforeseen sovereign collapses or cataclysmic environmental events. Big Black Swan occurrences are simply not normally distributed in the evidence behind most predictive practices.

What does it mean for business? It underlines the failure of modern theory to predict winners and losers in the marketplace.

For example, it is virtually a cliché that last year’s best performing investment fund will not hold those laurels at the end of the coming year, yet few people act on it.

Plenty of firms follow well-argued management fads but never reach the top of their industry. Many fail altogether. Others who follow nothing in particular can zoom to the front of the pack.

Who would have predicted Google’s dominance of the search engine space when Yahoo was still the front-runner? And let’s not even get started on Mark Zuckerberg and Facebook.

What can we do about this?

This is where the author’s suggestions disappoint. Not because they are wrong; rather that he reminds us of what we already know.

His “barbell” strategy – in which you might commit 90% of your business activities or investment portfolio to hyper conservative activities, and 10% to hyper aggressive ones – is essentially an extreme form of asset allocation.

You become exposed to the positive or negative Black Swans of extremistan, but you don’t bet the farm, which is quietly underwriting a more moderate existence in mediocristan.

If you want that exposure, that’s the decision you need to consciously make. Only in the closing paragraphs does the book focus on the central role of that decision.

Ultimately it depends on your ability to accept the unknown as just that. It is the extent to which you can comfortably live with the chance that your 10% will go either spectacularly right or spectacularly wrong.

Only then can you manage exposure to Black Swans with stress-free equanimity.

It is a level of detachment that’s a big ask for the average human being.