I spent my vacation surfing in Indonesia this summer, which meant I spent a lot of time thinking about investing in alternatives. What does surfing have in common with alternatives? Plenty. Looking at a wave, you have to decide if it's worth riding—is it a trend or just a directionless event? I had to make constant risk-reward calculations, and sometimes I passed up an opportunity. "If in doubt, paddle out"—a surfer's bylaw—sounds like the advice Warren Buffett gives: "You don't have to swing at everything."
When you become a surfer, you have to pay attention to not just the local weather, but weather thousands of miles away. Straddling my surfboard, I watched swells approach that had been formed months earlier by huge winter storms deep in the Antarctic Ocean. They had rolled across thousands of miles to reach Indonesia in August.
Similarly, big global macro events that originate halfway around the globe break on our shores. Remember what happened in March: The minds of investors from London to Los Angeles to Singapore were focused on Cyprus, a tiny island with fewer than 1 million inhabitants, when its banking sector needed a bailout. We continue to feel the ripple effects from Greece's economic crisis, Egypt's political turmoil and China's slowdown.
Thirty-five years ago, my friends and I would go on surf safaris to Mexico. Fueled by hot dogs and beer, we would take our chances on finding the good swells. Today, we rely on sophisticated wave-predicting software. When experts say 15-foot swells will hit the beaches of La Jolla, they usually get it right.
Extreme waves—"rogues"—are enormous waves that appear quickly and out of nowhere. They can be twice as big as surrounding waves, with steep sides and abnormally deep troughs. Because they are so rare, rogues are still poorly understood.
