Asymmetric Investing

It's pretty rare that anyone finds an investment that can't go down. Don't get excited, we haven't found it yet either. But we've got the next best thing: asymmetric investing. What if you could craft an investment thesis that mitigates a great deal of risk, but still gives you access to billions in corporate profits? Would you do it? This sort of opportunity exists in a number of commodity-driven sectors today (especially in the Energy sector), and it all goes back to the basics of supply and demand.

As an example, let's have a look at oil prices. First, we'll use economic growth as a proxy for demand. We know global economic growth is strong and widely forecasted to grow further. When economies grow they need more energy to make it happen (this is true even as economies become more efficient in using energy). So, we can conclude the demand for oil will continue to grow.

What about supply? In the short to medium term, adding incremental oil supply to the market is extremely difficult. It takes years (sometimes decades) to explore, drill, transport, refine, and deliver oil in usable forms to market. And today we're already operating at near production capacity globally. So, oil supply isn't going to grow quickly anytime soon.

This basic scenario of rising demand and steady supply translates to higher equilibrium prices for oil.

Sure, many investors already know that. And anyway, standard market theory says widely known information is priced, and only news with surprise power can move markets. So, where's the surprise power in oil supply? Here's where it gets interesting: almost all the risk (that is, surprise power) is with shortfalls in oil supply. Political turmoil, natural disasters, and aging infrastructures can all unexpectedly disrupt the flow of oil to market, yet we know that a surprise of new supply is virtually impossible for structural reasons.

If there's a higher chance of a surprise in supply disruption relative to the chances of a surprise supply increase, then the equilibrium price of oil has a lopsidedly high chance of rising more than most expect. That's the essence of an asymmetric risk—one outcome is far more likely than the alternative. This makes the chances of abnormally better profits at oil-related companies higher than most expect, too.

That's a lot of abnormality! That's asymmetric investing.

Here's an example from today's news:

Surprise: Oil Woes in Iran
By Staff, BusinessWeek
https://www.businessweek.com/magazine/content/06_50/b4013058.htm?chan=top+news_top+news+index_businessweek+exclusives