Exploring different ways to build asset allocations has always been a fun and fascinating topic. It's not so much that I want to deviate very far from some mix of stocks, bonds, and cash; but small deviations -- which I believe I've been practicing -- can be constructive for improving risk-adjusted results, avoiding trouble spots (how excited would you be about lending the government money for 30 years in exchange for 1.85%?), and better managing volatility.

I recently started following @trader_ferg on Twitter. He has some interesting opinions on asymmetry, which is something I've written about a lot over the last few years. In a recent Tweet, he cited some rules he's come to learn and incorporate into his trading process, including "asymmetry in all positions."

From what I can tell, he specializes in energy and is currently focused on the uranium space. Having asymmetry in all positions probably doesn't work in a typical investor's portfolio. If you're starting point is a mix of stocks and bonds and is building out from there, you're not realistically going to find an asymmetric opportunity in bonds or bond proxies.

In trying to come at asset allocation with a completely different framework than 60% stocks/ 40% bonds, the first sleeve might be bond proxies. In this category, we'd be looking for something that has similar volatility and return attributes, but without the interest rate risk that goes with lending money with rates very close to all time lows.

Trying to trade bonds for capital gains in a portfolio for an individual investor seems like it would be very difficult and has a "picking-up-nickels-in-front-of-a-steamroller" feel to it. For my own personal holding, as well as my clients', Merger Fund (MERFX) fits the bill as a bond proxy. In the last ten years, per Morningstar, it has only had one down year -- in 2015 when it was down less than 1%.

For the past ten years, it has been up a shade over 38%, which simplistically averages out to 3.8% per year, and it's deviation from that simple average has been modest. Draw your own conclusion, of course, but I am thrilled with how boring and steady MERFX has been.

One thing that MERFX is not is asymmetric.

A few investors who I have respect for are big believers in using tail hedges. This is something I've written about quite a few times and have been implementing in client portfolios for many years. This has become easier with the Cambria Tail Risk ETF (TAIL), which, again, is a client and personal holding.

It is essentially a treasury portfolio with some S&P 500 puts. It has generally gone from the upper left to the lower right, which is not ideal in nominal terms, but it does spike up when it is supposed to -- that is, when the market turns lower, and I expect that to continue to be the case going forward. Also it's deterioration in markets is much less than inverse funds.

Obviously, if managing volatility does not resonate with you, then you probably would have no interest in a tail hedge, but I think a small allocation can be effective yet not asymmetric.

Interestingly, TAIL doesn't look very much like gold, as measured by client and personal holding SPDR Gold ETF (GLD). Over the last 15 years, Morningstar shows the S&P 500 has been up 298% and GLD has been up 200%, but they have taken very different paths to those results. Occasionally the correlation does tighten up, as was the case in the middle of 2020.

The way I have worded it is to say that gold has the historical tendency of not reflecting the stock market very often. They trade differently often enough that I believe gold does offer diversification, but despite what others might say, gold is not asymmetric -- unless you want to bet on the end of the world and turn out to be right.

In the context of this exercise, a large allocation needs to go to broad-based equity exposure. Specifically I am talking about indexes like the S&P 500, the S&P 1500, or a global index; something that captures beta. If the US stock market has an average annual return in the sevens, then an investor with a decent savings rate and adequate time horizon can accumulate a sizable nest egg just by owning that beta.

15 years ago, there was plenty of chatter about needing to have 15-20% allocations for things like REITS, MLPs, or gold, which I said at the time was a terrible idea. Those would have been very large bets on narrow outcomes after big moves up for all three niches; kind of the opposite of asymmetry, as asymmetric investing involves small allocations to potentially huge payoffs.

I would add that I don't think of broad indexes or portfolios constructed to generally capture the index effect as having asymmetric potential. I'm assuming no one would think of the Russell 1000 or Russell 3000 that way.

In looking for asymmetry, things like Bitcoin (BITCOMP), lottery ticket biotech stocks, maybe even miners with unproven reserves, all could be thought of as having asymmetric potential.

How much should you allocate to asymmetry? Many years ago, I stumbled into this concept as expressed by Nassim Taleb, who said 90% should be in T-bills from around the world and then go with the other 10%. Back then, I didn't use the word asymmetry to describe the idea. The details from Taleb seem to have evolved, but he still believes in an allocation to asymmetry. I would add that he's been talking a lot more in recent years about an allocation into tail hedge, too.