On that ordinary Monday morning, nothing felt unusual. Nikhil finished his pranayama, walked Misha, his three-year-old Husky, and switched on the coffee machine to enjoy his morning brew. Then, he opened his laptop to check his mail. He saw the subject line and froze.
By the time the sun shone through the window, it seemed like dusk had set on Nikhil’s career. In one fell swoop, several thousand people in India were laid off with immediate effect by a leading technology company. For those who received the mail, it felt like the floor had caved in. Rarely does life follows a linear, predictable path. All seems to be going well when suddenly a job loss, health emergency, market crash, war or death can throw life akilter.
A few years ago, I read Antifragile: Things that Gain from Disorder by the renowned mathematician and statistician Nassim Nicholas Taleb. Taleb points out that merely striving for resilience during adversity is not enough. Rather, one must aspire for anti-fragility. Resilience keeps systems sustainable and functional during disruptions.
However, anti-fragile systems benefit from shock and disorder. Instead of sustaining or surviving, such systems prosper because chaos can create opportunities, and a completive advantage for the anti-fragile. “Fragile breaks under stress. Robust resists stress. Anti-fragile benefits from stress,” affirmed Taleb.
Most portfolios are built on the assumption that the world is mostly stable. What if that assumption were misplaced? What if disruption was the norm and stability the outlier?
Wouldn’t it be sensible to make our portfolios anti-fragile, so it withstands not only the toughest knocks, but also thrives in an increasingly VUCA (volatile, uncertain, complex and ambiguous) world? What then is an anti-fragile portfolio?
Think of an anti-fragile portfolio as a pyramid. The foundation or base is the strongest—wide, capable of bearing heavy loads, and able to absorb shocks. The second layer provides core strength and stability. The peak provides mobility and upward direction.
The aim of an anti-fragile portfolio is to protect downside, while exposing itself to the upside.
Foundation:
The foundation provides safety and the psychological freedom to pursue the anti-fragile strategy. The base does not chase returns. Instead, it compromises return for safety.
Money in the savings account, short-term fixed deposits, liquid funds, money market funds, arbitrage funds are instruments that form a strong base. They provide liquidity with minimal default risk. This layer must not include equity, real estate backed by mortgage, or any long-term investments. A broad base enables you to fund expenses for at least a yearwhile retaining enough dry powder to deploy to present or future opportunities.
An unlimited health and disability insurance cover is a non-negotiable component of the base. So is insurance for home, auto and other liabilities. Sudden cash outflows due to health issues can wipe out liquid assets in a flash. It will make you fragile no matter how well your other investments perform. A life insurance cover to protect your dependents is necessary so the pyramid survives beyond your lifetime.
The strength of the base is derived from low or no debt. Debt can cause cracks in the foundation. Fixed commitments can deplete cash flow, and force you to sell high-quality investments early. You will be constrained to make sub-optimal life choices, such as accepting a poor job offer, or selling a property at its lowest saleable value. Anti-fragility requires time, but fixed commitments corrode time. Low debt keeps time on your side of the game.
Core:
The job of the core is to steadily compound your assets. The core is built with investments that provide relatively stable, predictable growth. These investments are diversified, flexible and mostly liquid. Diversified portfolios exhibit negative correlations among assets. Hence if some assets underperform, other outperforming assets negate the underperformers to some extent. However, in a market crisis, correlation often turns positive, reducing or eliminating diversification benefits and creating portfolio fragility.
Liquidity is a critical attribute of the core. Prioritize liquid investments over those that are either locked, cannot be liquidated quickly, or can be liquidated but with penalties. Create this layer using a mix of high-quality, long-term equity and debt assets, such as large-cap, multi-cap; hybrid funds (balanced advantage, multi-asset or other asset allocation funds); short- to medium-term debt; and other high-quality fixed-income assets. Introduce global diversification to reduce concentration risk.
Peak:
The peak is where anti-fragility sets up shop. The peak surveys its surroundings, constantly seeks opportunities, and thrives in disorder. Remember the apex of the pyramid is the smallest part of the structure. Even if it collapses, it does not harm the entire structure. So, ensure the apex does not exceed 10% of your financial portfolio.
The assets that reside at the peak are not meant to be steady, predictable or safe. It is here that you place your sectoral, small-cap, or emerging business bets; venture capital investments; long-short strategy investments; or those with employ derivatives and leverage. The apex may underperform, causing stress for extended periods.
But when the bets pay off, the outperformance can be exponential.
That Monday morning email was a turning point in Nikhil’s life. He realized that disruptions are the norm in today’s world. Even though the world is less predictable, he could be more prepared. His portfolio would be anti-fragile—it’s foundation, rock solid; it’s core, strong; and it’s peak, ready to seize the future on its own terms.
Priya Sunder is a director and co-founder at PeakAlpha Investments.