Should Asymmetric Risk Be Its Own Asset Class?
In his podcast today, Gil Weinrich took a look at the potential merits of investing in themes like blockchain and marijuana. He said he weighed through some potential investments and concluded the odds of panning out favorably are low. I'm pretty sure he never used the term asymmetric risk but that's what he was talking about.
My introduction to the concept pre-dates my having heard the term asymmetric risk, back to an idea put forth by Nassim Taleb many years ago where he believed in putting 90% of your money into T-bills from around the world and 10% into very risky stuff that has the potential to go up dramatically but where crapping out was a distinct possibility. The specifics of how he's presented the idea have changed but the concept hasn't; put a small portion into very risky investments, or maybe speculations is a better word.
I've been writing about both blockchain and marijuana for a while now. At 30,000 feet I think there is no question that the apparent benefits of both mean that blockchain and medical marijuana (and CBD) will become an ever larger part of daily life, they are going to happen (in my opinion). However there is nothing that says that the current batch stocks and ETFs to invest in must be the ones that end up being the winners. The winners might not even exist yet and that is where the risk is. Like the internet theme from 20 years ago, blockchain could exceed every expectation we have but there is nothing that says any of today's stocks must be apart of that outcome. Ditto marijuana.
The above is also how I've described investing in Bitcoin. There is no question that faster, more secure electronic transactions are going to happen but there is no reason that it must be Bitcoin, the winner could be some yet to be created cryptocurrency. I do believe the asymmetry is much greater with Bitcoin than the blockchain or marijuana equity themes meaning much greater chance of either zero or going to a gajillion.
Jim Bianco came on Bloomberg TV today and said that were are permanently in a 1%, maybe 2% interest rate world. I don't know if he literally meant forever but certainly for a very long time in his opinion. This becomes problematic for allocating assets to build a diversified portfolio of which bonds have been so crucial. Higher yields are of course available in quite a few parts of the income market but they take on more risk and so smaller allocations make sense in terms of how risk is managed. I'm a believer in bank loans and high yield bonds but I would not want to allocate to them in the same proportion as treasuries or investment grade corporates. We've looked at plenty of liquid alternatives that can serve as fixed income proxies (this requires a lot of work as plenty of alts will not fit this bill despite what the marketing says), I've had good luck with merger arbitrage in this context among others.
The reality of interest rates for the time being is one reason to ponder whether asymmetric risk should be a separate asset class in an asset allocation. In thinking about 60% to equities and 40% to fixed income as the starting point for understanding what about;
- Equities 60%
- Traditional fixed income 24%
- Alternatives that are true fixed income proxies 14%
- Asymmetric risk which could be crypto, certain equities, other markets 2% (no more than 1% in any single holding)
The point is not to get hung up on the percentages but to explore the idea. We revisit this topic every so often and have been consistently negative on thinking that things like REITs and MLPs could be fixed income proxies, they are not. The closest they might come is as low volatility equities but of course each group has taken turns getting crushed in the face of adverse market circumstances.
A successful bet (that's what they are, bets) on an asymmetric outcome like Bitcoin can help make up for some of the yield no longer available in the fixed income market. A 1% initial allocation that grows ten-fold over a few years will add meaningfully to a portfolio's overall return in that period but if it goes bust, the drag is minimal. In dollar terms for a portfolio starting at $800,000 with $8,000 in blockchain stock, if that $8,000 grows to $80,000, the impact on the portfolio is substantial.
It may not be easy to have the nerve to hold on after a successful bet doubles but that isn't really the objective with an asymmetric bet. If your portfolio is mostly comprised of individual stocks that are not asymmetric bets it is not unreasonable to think that one of them might double pretty quickly, that's a scenario to consider reducing exposure but I wouldn't do that with some sort of lottery ticket holding.
For now, this is not something I do in client accounts and don't know when or if I ever will. Taking Bitcoin as an example, there is nothing underlying it. There are no corporate assets (plants, equipment, IP). there is no shiny metal that people place value on and there's no full faith and credit of a government. Bitcoin proponents view this (decentralization) as all being positive and maybe they will be right but for now, I can't see investing client money in something where zero is a reasonably probably outcome. I've been back in Bitcoin with a very small investment for almost a year but it would be naive to think zero as an outcome is off the table.
For now, I feel like the alternatives I'm using (what I believe are true fixed income proxies) and the traditional fixed income are getting the job done but the manner in which asset allocation might evolve is a concept that I believe advisors need to continue to explore.