Asymmetric Bets, Venture Capital & Cancer Cells

Perhaps the most significant is that it’s not whether you’re right or wrong that’s important, but how much money you make when you’re right and how much you lose when you’re wrong — Stanley Druckenmiller

I’ve been obsessed with asymmetric bets and looking for them wherever I can find them.

These are bets where you have disproportionate upside relative to downside risks. A simple example is where you pay $100 for one share where your maximum downside is $100 but there’s no cap on the maximum upside.

Other asymmetric activities include going on first dates (potential upside: someone that changes your life), reading books (an idea that changes your life), starting/investing in a company (money that changes your life), and so on.

You can also have asymmetric risks happen the other way around (for example, short selling where you can theoretically have unlimited downside).

A example of what to avoid is the Archegos debacle where the investment banks made a small fixed fee but had a disproportionately large exposure to the downside.

The following are my principles for thinking about asymmetric bets.


Principle 1: Look for Leverage

Illustration by Andrew Yu

My favourite kind is where there’s some form leverage involved, for example through capital, labour or distribution.

On capital, you gain leverage in a lot of ways including through derivatives.

On labour, Ray Dalio wrote in his Principles, At 50:1 leverage, for every hour I spend with each person who works for me, they spend about 50 hours working to move the project along… Leveragers are people who can go from conceptual to practical effectively and do the most to get your concepts implemented.

On distribution, this can be through the internet with software code, YouTube videos, blog posts, Tweets, etc.

As Naval Ravikant once said, we live in an age of infinite leverage.

Once you figure out points of leverage that falls under your unique ability or circle of competence, you don’t need to work hard. You just need to work smart.

Principle 2: Look for Uncertainty

You generally have much higher potential returns when you have maximum uncertainty or maximum information asymmetry.

Look at things that are hated, not understood, things people think will never work or where there’s some kind of fundamental shift that’s not being recognized.

The whole point of asymmetric bets, for me at least, is to swing for the fences with minimal downside risk.

Some signs of high uncertainty can be frequent points of failure or higher rates of trial and error.

On the other hand, when Facebook first listed, there was uncertainty about its ability to generate profits and even bigger uncertainty during its pre-IPO days.

Source: Barron’s

Now that Facebook’s a money printing machine, the certainty of growing future cash flows have been priced in by the market.

If everyone from your hairdresser to your next door neighbour are talking about something, you’re probably too late to the party.

Does that mean that you can no longer make money on shares that everyone else owns?

Of course not.

There are plenty of good investment opportunities in widely covered stocks and many investors would argue that Facebook is still indeed a great investment.

The point is that your odds of having maximum information asymmetry is lower and your risk is higher, especially when everyone is feeling optimistic about something that you want to go long. Or if everyone is feeling pessimistic about something that you want to go short.

That’s not the sweet spot for asymmetric bets.

Your cost of entry is higher.

As Charlie Munger likes to say, fish where the fish are.

Fish where there’s maximum uncertainty.

A question I like to ask to serve as an indication, Does This Make Sense To Everyone Else?

For example, imagine the very early days of Crypto and having to explain what it is and how to buy it.

Or advertising online when advertising on TV was all the rage.

Principle 3: Look For Your Edge

If you don’t think too good, don’t think too much — Ted Williams

What separates you from making a good bet as oppose to gambling blindly is having some kind of insight.

This is your edge.

If you have no idea about markets, you can make hundreds of bets and lose money overall.

If you know nothing about advertising, you can create hundreds of ads and not land on a winning campaign.

On the other hand, if you have some special insight about an industry, market, company or product, then you can make bets where you see asymmetry.

For example, you can make bets with “cheap” out of the money options on events that the market views as 1 in 1,000 but that you see as closer to 1 in 50. Markets are generally pretty good at predicting outcomes, but generally not very good at anticipating black-swan events. Make enough of these kind of bets and the market will eventually reward you.

You don’t need to be an expert when you first start off and we all need to start from somewhere obviously.

But you need to be in the game long enough so that you can learn from your bets, reflect, make some conclusion, and then bet again. Over time, you start skewing the odds in your favour.

This is why ideas are a multiple of execution.

Your ongoing thinking and your ongoing execution will mean that your odds of success is not static but constantly changing over time.

Better judgment will increase your odds over time until one day they become a near certainty in some cases.

Consider the odds of success if you give $1 million to Warren Buffett to manage or $1 million in advertising for ad copy that Dan Kennedy has written.

Think about the difference between writing your first blog post and your 10,000th blog post. The difference between reading your first annual report and your 10,000th. Your first YouTube video and 10,000th.

In the early phases, more priority should go towards putting in your repetitions. You can spend all your time researching how to make perfect YouTube videos that goes viral without ever making any videos. Or you can start making imperfect videos immediately and get real-time feedback.

Developing your edge will be easier if it’s something that you love so that you’re naturally curious about it and constantly working on your craft, regardless of the results or outcome.

In his book Zen and the Art of Motorcycle Maintenance, Robert Pirsig talks about taking his motorbike to a repair shop where a bunch of young men playing loud music while butchers his bike. I imagine that to the kids, fixing the bike was just a mundane process to be over and done with. To Robert, each part of the bike expresses a unique function which together acts in symphony to produce motion.

How you do something matters just as much. You can do 10,000 iterations but if you’re just going through the motions and don’t really care about how you’re doing it, your edge is going to differ from someone that’s doing the same thing, but with a lot of care.

Principle 4: Be Aware The Entry Fee

For every bet you place, there will be an entry fee.

The entry fee doesn’t necessarily need to be in terms of money only. It can be in terms of opportunity cost generally.

Your current position matters. If you’re managing $200 billion, spending the year looking for opportunities with a potential payoff of $20 million probably isn’t the best use of your time. But if you’re managing $1 million, then it very well be worthwhile.

The stage you’re at also matters.

If I can make three good decisions a day, that’s enough, and they should just be as high quality as I can make them. — Jeff Bezos

A billion dollar company should have only a few high quality initiatives per quarter. A new start up on the other hand needs a dozen new initiatives per day just to stay alive. Without massive amounts of daily activity from you, your start up will be dead in the water.

As a very general rule of thumb, the earlier you are in the journey, the more should be striving for maximum iterations with lower entry fees.

This is closely related to looking for your edge.

Ask yourself, How Can I Maximize My Iterations At The Lowest Possible Cost?

If you want to write a book, one possibility is writing a lot of Tweets or Blog Posts to develop your writing style, your audience and to understand what actually works.

Instead of developing a ready software or physical product, you can pre-sell the product using mock ups, prototypes, landing pages and so on. The latter means you can try many iterations while learning about your market.

The entry fee needs to be judged against the payoff.

A bet of $50,000 with a 60% chance of paying $10 million and a 40% chance of total loss can be a good bet to make.

Once the bet is made and let’s say you lose all of the $50k, then it will probably look stupid to everyone else and look like you have no idea what you’re doing. Especially if you’re in the public eye.

Ultimately, the main thing that matters is that the bet was the result of a good decision making process based on the information that you had at the time.

Consider the Fire phone. Amazon had written off $170 million dollars because of that “epic failure“. But was it a bad bet because it failed?

Of course, it’s easy to judge after the fact. What matters is what they knew during the decision making process. Bezos knew that it could go to 0. They looked at the potential payoff against the downside and decided to go ahead.

A bad result doesn’t necessarily mean a bad decision. Rather, the bet should always be judged based on the decision making process.

The Fire phone didn’t work out but Amazon’s other consumer electronics like the Fire TV and Echo has done very well.

Having “failures” generally is a good sign that you’re swinging for the fences.

The entry fee needs to be judged against your ability to continue playing.

What if $50,000 is all you have? I guess it depends on your risk tolerance and the odds but generally you want to be able to stay in the game long enough so that your odds will play out.

Principle 5: Be Patient

The type of game you’re playing matters. The principles of one game doesn’t necessarily carry over to another.

In baseball, you get 3 strikes and you’re out. You can wait for your sweet spot only up to a degree.

Source: The Science of Hitting

In Blackjack, you’re betting often. But you can vary the size of your bets according to your odds.

In investing, you can swing just a few times (with concentration) during your lifetime and still be wildly successful but only if you have the patience to withstand the price gyrations and popular opinion.

One of the most successful bets of all time was from a little known South African company, Naspers.

They invested $32 million into Tencent in 2001 that has now blossomed to over $200 billion. They were constantly pressured by their own investors to sell at every step of the way. It’s not easy to hold something that’s flipped so many times. Your natural inclination is to “lock in your gains” or to “trim your profits.”

If they sold at $100 million or $1 billion, that bet would have been considered a huge success by many people’s standards. But the guys at Naspers held patiently onto their conviction and it payed off in a big way.

Consider Amazon in the early days. If you read this piece from Barron’s:

jeff bezos, amazon
Barron’s on the money again

And then you look at the stock price of Amazon for the next few years:

Phew… avoided that catastrophe!

You probably would have concluded that Barron’s got it right.

If you had a substantial sum of money in Amazon shares during this period, it most likely would have been difficult to stomach these drawdowns over what must have seemed like an eternity.

It doesn’t really help when you’ve got the media declaring that the stock market has finally realized that Amazon is a Mickey Mouse business. At same time, you see so many other stocks that are going up, up. Ouch.

It’s always easier said than done to be patient.

It’s hard in practice to hold onto winners through the good times and bad.

In Facebook advertising, the number of bets you make is subject only to your ability to generate creatives and offers, and your ability to continue paying for them.

Stomaching wasted time and money on Facebook ads and landing pages can be hard when you see no results.

As Naval likes to say, Impatience with actions, patience with results.

If you find a play within your sweet spot but it doesn’t work out immediately, don’t leave the game.

Rookie Facebook advertisers will often kill campaigns too soon because they didn’t make money immediately and it hurts to spend advertising money with no results. It feels pointless to keep on working on new creatives and having to spend even more money.

Investors get impatient because instead of doubling, their shares have gone nowhere for a long time or decline while meme stocks end up surging and they end up selling based on price action alone.

The stock market is a device to transfer money from the impatient to the patient — Warren Buffett

In baseball, being impatient can mean taking a swing when you shouldn’t have.

For bets to play out fully, patience is needed.

This can be difficult, especially when there’s high uncertainty and a lot of noise.

There are no guarantees. It’s not like studying to be an accountant and passing an exam.

But that’s the whole point and why returns are asymmetric.

You can get a wider distribution of possible outcomes with more uncertainty.

If you’re going to be impatient with anything, be impatient with things that are within your control. Focus on the controllables.

Enhance your edge.

You can control how much you train for your baseball games. You can control how much effort you put into your advertising creatives. You can control how much effort you put into your investment research. And you can control the quality of your effort with which you do these things.

Tying It All Together

It is not the strongest species that survive nor the most intelligent but the ones most responsive to change — Charles Darwin

I recently read Jason Fung’s excellent book Cancer Code and realized that there are some similarities between these principles and how cancer cells operate.

In a nutshell:

  • Each game that you play is an iteration where other players (and in some situations NPCs) are also playing
    • For example, algorithmic trading bots making bets vs people making bets in capital markets.
  • There’s typically an entry fee in energy, time, resources
    • A new article takes time and energy to write up. Investing takes capital.
  • More iterations will increase your odds of success
    • The power of focus comes from building up concentration and improve your edge in your domain
  • You can vary the size of your bets to maximize the number of iterations
    • Writing Tweets/Blog Posts vs A Book
    • Presell Software vs Build Full Software and then Sell
    • HR: Test Project/1 Month Trial Hire vs Full Time Permanent Contract
  • Incorporating feedback will increase your odds even more
    • Given our biases and beliefs, processing feedback rationally is not easy but those that do it well have a big edge. By focusing relentlessly on the question, Does It Work? through each iteration can help.
  • Patience
    • This means being able to stay in the game while being responsive to feedback. Your odds of success can start low but end up being very high
  • To the winner goes the lion’s share of winnings
    • Consider Joe Rogan vs the average podcaster. In an age where the cost of distribution is close to zero, the returns will generally skew to the top players. I imagine that before the radio became mainstream, local performers on average did quite well for themselves. Then comes the radio and more of the overall earnings started to shift to the best known artists.

Cancer cells:

  • Cancer cells are competing with other cells for resources to be able to survive and thrive
    • Businesses compete with each other for attention, money, talent, etc. to grow
  • Their form of leverage is through duplicating themselves — they grow by dividing
  • They’re constantly evolving and experimenting by invading new environments which costs resources
  • Invading new environments is a highly uncertain endeavour that will mostly fail
  • Nature is the feedback mechanism.
    • Their iterations either survive or they’re killed by the body’s immune system. Mutation is the result of their imperative to survive under selection pressure
    • This reminds me of Edison’s quote: I have not failed. I’ve just found 10,000 ways that won’t work. Similarly, cancer cells tries many variations that don’t survive. There are many different types of nature’s feedback mechanisms such as consumer behaviour, financial markets, biology, physics, etc.
  • The rare mutant variation that survives its hostile environment ends up thriving
    • They proliferate and become dominant in the host
  • This process requires time and can take years or decades

Action Points

  • What is your “edge”? What is it that you do best?
    • AKA your superpower, your circle of competence, your unique ability.
  • Where do you see asymmetry in your own life? Where are they leveraged and where are they not leveraged?
  • Are there ways you can make bets to greater effect?
    • For example, varying the size of your bets

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