The Paradox of Symmetry
While we often celebrate symmetry and balance in life – from balanced diets to symmetrical architecture – in investing, this intuitive preference can be counterproductive. For sophisticated investors, asymmetry in risk/return profiles often yields superior results.
This seems logical, who doesn’t want to make more than they risk. But the reality is that this asymmetry isn’t all that easy to capture.It turns out there’s a lot of investments out there clamoring for your hard earned money which actually have an upside down profile where the risk is far too great for the return they offer.
Good asymmetry: Small risk, large potential return
Bad asymmetry: Large risk, small potential return
The Mathematics of Asymmetry
Skew is the statistical measure of the asymmetry in a return distribution. A set of returns made up of frequent small, lower than average, returns and occasional large gains would be positively skewed. Conversely, a set of returns with frequent small, above average, returns and occasional large losses would be negatively skewed.
Most traditional investments (like stocks) exhibit negative skew (bad asymmetry investing)- they go up slowly and down fast, tending to have periods of small, consistent gains, interspersed with rarer periods of sharp losses.. Many alternative investments exhibit positive skew (good asymmetry), where they have longer periods of flat to down performance interspersed with rarer periods of large outperformance.
Positive Skew – Good Asymmetry
- Frequent small, lower-than-average returns
- Occasional large gains
- Many alternative investments exhibit this pattern
- Longer periods of flat to down performance
- Rare periods of significant outperformance
Negative Skew – Bad Asymmetry
- Frequent small, above-average returns
- Occasional large losses
- Most traditional investments (like stocks) show this pattern
- Go up slowly and down fast
- Periods of small, consistent gains interrupted by sharp losses
This mathematical reality challenges conventional wisdom. While negative skew investments look better in normal times, they harbor hidden risks that manifest in devastating drawdowns. Positive skew investments, though harder to stick with, offer better long-term wealth protection and growth potential.
Four Asymmetric Investment Strategies
What types of investments have this type of “good” asymmetry. Here’s four that fit the bill:
1. Trend Following
- Systematic risk management
- Small, controlled losses
- Uncapped winning trades
- Multi-market diversification
CTA to Trend Following Guide: Trend Following Guide
2. Options Buying
- Downside limited to premium paid
- Unlimited upside potential
- Clear risk parameters
3. Venture Capital
- Capped downside (initial investment)
- Potential for exponential returns
- Portfolio approach essential
4. Distressed Assets
- Built-in price floors
- Below-intrinsic-value entry points
- Multiple value catalysts
- Substantial upside potential
The Psychology of Skew: Why Investors Choose Wrong
Most investors unknowingly gravitate toward negative skew investments that have upside down risk/return asymmetry – strategies that deliver steady, small gains but harbor hidden catastrophic risks. This psychological bias occurs because:
The Illusion of Stability
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- Negative skew investments feel “safer” due to consistent small wins
- The steady performance creates false confidence
- Hidden risks accumulate beneath the surface
- When crashes come, they’re devastating
The Challenge of Positive Skew
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- Extended periods of flat or negative returns test patience
- Choppy, inconsistent performance feels uncomfortable
- Requires tolerating frequent small losses
- Large gains come unpredictably and infrequently
Why Investors Abandon Good Strategies
Many investors start with the right intention – seeking positive skew investments for crisis protection and lumpy upside. However, they often:
- Become discouraged during long periods of underperformance
- Question the strategy during strings of small losses
- Compare unfavorably to steady performers during normal markets
- Exit positions just before significant payoffs materialize
Building Psychological Resilience
Success with positive skew strategies requires:
- Accepting that discomfort is the price of admission
- Understanding that smooth returns often mask hidden risks
- Focusing on the role of each strategy in your portfolio
- Maintaining conviction through extended drawdown periods
FAQs About Asymmetric Investing
“Is asymmetric investing risky?”
All investing has risk, but asymmetric investing is about making those risks work in your favor. You’re looking for situations where you risk a little to potentially gain a lot.
“How do I find asymmetric opportunities?”
Start by looking for:
- Oversold markets
- New technologies
- Beaten-down quality stocks
- Special situations like spinoffs or mergers
“Do I need a lot of money to start?”
Nope! Many asymmetric strategies work with smaller amounts. Options trading, for instance, can start with relatively modest sums.
The Bottom Line on Asymmetric Investing
Asymmetric investing isn’t just another investing buzzword – it’s a smart approach to growing your wealth while managing risk. By focusing on opportunities where your potential gains far outweigh your potential losses, you’re setting yourself up for long-term success.
Remember: the goal isn’t to swing for the fences every time. It’s about finding those special situations where the odds are heavily in your favor. Keep learning, stay patient, and don’t bet more than you can afford to lose.
Want to learn more about specific asymmetric investing strategies or see some current market examples? Just ask! This stuff gets really exciting when you start putting it into practice.
The Bottom Line
While symmetry appeals aesthetically, and negative skew investments feel safer, asymmetric positive skew strategies can offer better wealth-building potential; especially when paired with their negative skew compatriots. The challenge isn’t finding these opportunities – it’s having the psychological fortitude to stick with them through inevitable periods of uncertainty and underperformance.
Want to dive deeper? Here’s a few episodes of ‘The Derivative’ where we dig into asymmetry and skew with hedge fund pros:
