Skewing To An Unrealistically Good Result

All sorts of fun stuff today but no post yesterday because we had this going on. 

Two fires in three days doesn't happen here very often. I was first on scene with another firefighter. We knew other resources were coming so the immediate objective was to try to prevent it from getting worse and start to knock it down. Despite what it looks like, I am not directly under the power line.

We'll kick off with comments that Ken Griffin gave to Bloomberg, he said that diversification is the most important thing for newer investors because "your likelihood of beating the pros as a novice investor is low." I would argue of course that "beating the pros" is the about the last thing any investor should worry about, new or otherwise. 

Here's the one thing, with regard to portfolio outcomes, that matters most. Do you have enough money when you need it, for as long as you need it? That's it. Dusting off an old one, quick, without looking, what did the S&P 500 do in 2017 and did you outperform or lag? That odds that anyone knows without looking are microscopic because it doesn't matter. If you're 50 and only have 1/3 of what you should have by now, you're not going to outperform your way up to where you should be. If you're 85 and very fit but out of money, whether you outperformed from 1990 to 2000 means nothing. 

This is part of the reason we spend so much time here trying to figure out how to make the ride smoother over the long term. A very volatile portfolio increases the likelihood of panicking or making some other behavioral mistake. 

On Tuesday, I sat in on a webinar from ReturnStacked about the newest ETF that leverages up to own stocks, gold and Bitcoin that has symbol RSSX which we've looked at a couple of times. I won't bore you with more about that fund but they made a high level characterization of their strategy that I thought was interesting. Most of their funds they said offer a very basic asset class with an alternative added on top. The benefit as they see it is when deciding to use alts, you have to figure where to take from, stocks or bonds, to add the exposure. So 60/40 might become 50/30/20. With their funds, it can be 60/40/20.

The AQR fund QSPIX is the sole alt in portfolios 2, 3 and 4. I chose QSPIX because it has been around for a while and doesn't have a return that is so good that it might not be repeatable. And despite the so-so CAGR, it appears to have been an effective diversifier over the years. 

Looking at portfolios 3 and 4, the leverage gets you nothing. It lagged by a basis point so ok, it's a push and Portfolio 4 was a hair more volatile. Maybe it is something about my method but it is difficult to put something together using retail accessible funds to get their concept to work. I go through this so often trying to find a compelling result and it is just hard to do. 

In a similar vein, Simplify posted a paper in support of some of their alt funds. They tilted to 50/30/20 but they made a useful point about needing to discern between alts that actually offer differentiation versus equities and fixed income. Private credit is often considered an alt but they question private credit's usefulness as an alt. Maybe some private credit fund you might access will outperform regular credit or maybe not, but there's not a lot of differentiation. 

The paper highlights their managed futures fund, the new currency fund with symbol FOXY, their commodity fund and the new high yielding fund that uses something called barrier put options, symbol XV. Taking the 20 in the 50/30/20 and dividing it up equally with similar, but older funds and building out a 50/30/20 with the following.

So there is some differentiation. This 50/30/20 lags a little is a little less volatile, it did noticeably better in 2022 but not the other drawdowns.

What I built though may not be fair to Simplify. Their currency fund FOXY might end up being much better than CEW. Some of the Simplify funds do fantastically well and FOXY could be one of those but obviously at this point there is no way to know. 

We'll close out with a couple of new funds. I've mentioned client holding Alpha Architect Box ETF (BOXX). It is long and short S&P 500 calls and puts in such a way that the return mimics the yield on T-bills without owning T-bills. The much newer Twin Oak Short Horizon Absolute Return ETF (TOAK) appears to seek the same outcome with a slightly different option strategy. TOAK appears to be long a couple of straddles but not short any options. 

I threw in client and personal holding MERIX for a little context. MERIX is essentially a horizontal like that tilts upward yet it looks far more volatile than BOXX or TOAK. I own BOXX for clients to have a little less direct Treasury exposure in case there is some sort of unforced error with something like the debt ceiling. To be clear, I am not worried about the US being unable to pay it's bills, more like congressional dysfunction leading to something stupid. If a strategy like BOXX or TOAK interests you, I would not own both, I believe they are too similar to own both. 

Finally, WisdomTree launched a new capital efficient (leveraged) fund that focuses on inflation, the WisdomTree Inflation Plus (WTIP). The breakdown is 10% cash for collateral, 85% in TIPS, 5-10% to Bitcoin and 95% in commodities of which, 15% is long gold and silver. The other 80% of the commodity sleeve can be long, short or flat energy, metals, grains and softs based on momentum. 

Trying to backtest the WTIP allocation might not be too helpful. If the results of Bitcoin are not repeatable, it going up 10x would be less of a gain than looking backwards, then any sort of backtest will skew to an unrealistically good result. 

Capital efficiency is of course a fascinating method (I think it is anyway). I don't employ it with traditional leverage. If I do anything with it, it is with leveraging down as we have described it before with a small allocation to BTAL as more of a long term hold and a couple of others that are a little more tactical. We're seeing more fund providers start to offer capital efficient funds. This is something that would be easy to misuse or otherwise get wrong. Relative to the providers out there, I  think WisdomTree has it pretty dialed in as far as funds meeting expectations.

The information, analysis and opinions expressed herein reflect our judgment and opinions as of the date of writing and are subject to change at any time without notice. They are not intended to constitute legal, tax, securities or investment advice or a recommended course of action in any given situation.

"Prosperity Paradox"

Well known minimalist Joshua Becker wrote about the crossover between minimalism and financial independence. The first level of this is easy to piece together, spending less on unnecessary crap is a path to financial independence. 

There are also psychological factors at play here too. As some point, people become overwhelmed by their stuff/junk for whatever reason and life becomes more difficult than it needs to be. Woven in there was what Becker referred to as the "prosperity paradox." The more money we have, the more we think we need which creates a tough, emotional treadmill. 

The one story about the prosperity paradox I've shared was a former co-worker when I was at Charles Schwab. I worked on a three person trading desk and one of the other two guys had been with the company going back into the 80's. The third guy and I each started in January 1993. By 1999, Schwab's common stock was getting close to $100 and my colleague had well over $1 million in company stock. 

Part of our compensation was stock and the way it was structured, the only we he could have accessed it would have been to quit/retire once vested. We urged him to do just that and he said, I need $5 million. You know the rest. The internet bubble popped and Schwab stock, which is a client holding, fell 84%. Schwab didn't retake that high until early 2017. I got laid off in Sept 2001 so I don't know how long he stayed at Schwab but if it was a long time, then he obviously accumulated a lot more stock at lower prices. 

An idea from many years ago that we revisit occasionally is figuring out what we really value and then saving or planning toward that correct outcome. Too many people have trouble figuring that out for themselves and they end up saving or planning for what turns out to be the wrong (for them) outcome. 

I've told the story 100 times about not wanting to be a partner at my old firm. Not realizing that many years later, one of the partners would turnout to trade illegally and that the other would let it happen, I disagreed with the complexity they seemed to embrace buying a building and starting a private equity fund among other things. I was reminded of another point in this post from Michael Batnick. I used to say this exact thing all the time. The job of running an advisory is much different than simply being an advisor. 

If someone wants to be an advisor because on some level they enjoy markets, helping people or some combo of both, time spent running the business isn't either of those things. 

Every aspect of life is easier when you know what you actually care about and what you actually want.

And a quick correction from yesterday, the picture of me spraying wet stuff on the hot stuff. I don't think that was me actually. White helmet (usually chief color) and tan pants is me but what little you can see of the glasses is wrong. He must have been part of the task force that showed up later. The other picture of me where I say I look like Vincent from Pulp Fiction, that was me.   

The information, analysis and opinions expressed herein reflect our judgment and opinions as of the date of writing and are subject to change at any time without notice. They are not intended to constitute legal, tax, securities or investment advice or a recommended course of action in any given situation.

Wildland Fire Today

Saturday was Walker Day which is our big, annual fundraising event and then Sunday morning we were dispatched out to a wildfire shortly after 4am and I didn't get home until about 3:45 the afternoon so no blog post but some pictures,

I started out as the Incident Commander (IC). I called it in at two acres, the final count was 2.9. There is a thing where volunteer departments are known to call in much bigger acreage than it really is so I felt good about that. 

From a few miles away.

We got lucky with a weather phenomenon known as the inversion layer and the fire laid down. 

The sun started to hit it, heating things up a little bit.

I can't believe our department has a truck like this. We sort of actually have two of them!

I turned over IC to the Forest Service after about an hour or hour and a half. That is some of their folks,

A little more technical, I established and Alpha division and a Zulu division. Our personnel took Alpha side and that is what they had to climb in the dark. Zulu started out with city resources but then we all engine crews were released.

From around 8am until 4:30 pm we provided water tender support (brown water truck is one of them)

That's me putting wet stuff on the hot stuff.

I look like Vincent in Pulp Fiction when he's picking up Mrs Wallace and he's looking around confused when she calls him on the intercom. It's a little hard to see but I am wearing a bladder bag which is a backpack sort of thing that holds 5 gallons of water and and the way it works, you can put out a lot of fire with them. 

We got lucky with a lot of things but our tactics weren't wrong, we had a tremendous number of resources respond and were able to take care of business. Our crews did a fantastic job.

Twitter Experts

One of funniest aspects of Twitter is in the immediate aftermath of some event like yesterday plane crash in India (not funny), there will then be a lot of opinions voiced to dissect the news/event. The funny part is the Tweets that say something to the effect, here come the Twitter experts on aviation safety or vaccinations or whatever. 

I have opinions on what has gone on in the middle east since October a year and half ago of course and I take in the news like many people. While we are all entitled to our opinions, I am certainly no expert of the geopolitics of the middle east or anywhere else. In terms of managing client portfolios, I believe the important thing is making portfolios robust in the face of whatever might come along to create an adverse market reaction. 

Something like Israel attacking Iran would seem to have the potential to cause a market decline but I have no idea. As opposed to trying to predict the effect some event will have on markets, I want portfolios to be generally ready for whatever negative surprise might come along regardless of my ability to analyze that event.

That brings us to the prompt for today's post from Bob Elliott who posted a short video saying "most investors are totally unprepared for war." He went on to talk about the shortcomings of the typical 60/40 portfolio in terms of lacking robustness in the face of war and I would add, in the face of just about any serious event that takes markets down. 

Specific to war, Bob says that stocks and bonds underperform. Owning just stocks and bonds, Bob says, is a huge bet on growth and low inflation. He suggests owning gold and commodities and keeping in the same vein I would add commodity stocks to Bob's comments. 

The way we've talked about first responder defensives and second responders hopefully is useful for readers, it is for me. No matter what causes the market to go down, an inverse fund is going to go up. Client/personal holding BTAL has been extremely reliable in this regard but is not infallible. 

Loading up on just one defensive is a bad idea in case something goes wrong but for me, after an inverse fund and BTAL it boils down to assessing reliability or maybe predictability is a better word. How reliable do you think gold and other commodities are in a defensive context? If you believe in any of this then I'd suggest going through a similar process of weighing out what the correct expectation is for any alt you own and any you'd consider.

Down a lot, up a lot, flat or bouncing all over the place, the result for client/personal holding Merger Fund this year is exactly what I would hope for in all market types. 

We spend a lot of time here trying to better understand what to expect from managed futures. It worked so fantastically well in 2022 and struggled badly in recent times. In 2022 in the face of fantastic outcomes and calls for 20 or more percent in managed futures I was very clear about what a bad idea I thought 20% was because you never know when it won't "work." Work is obviously not the correct word, it's doing exactly what it is supposed to do, it's just that the trendless nature of quite a few markets don't let themselves to favorable result. If you have 5% in managed futures as one of several alts, then the result this year can just be a shoulder shrug. With a 20% allocation, the impact is more serious. 

The ReturnStacked guys have another paper out in support of their version of portable alpha, leveraging up to add managed futures. 

Citing work from the Man Institute with the above chart, you can see the results of adding a larger allocation with leverage. Just looking at the chart you can see a lot of outperformance in the popping of the internet bubble. There was outperformance in the Financial Crisis, it's visible on chart but a little harder to see. We do have a fund we can look at for 2008 with what started out as the Rydex Managed Futures Fund that still trades with symbol RYMFX. That fund was up just over 6% in 2008. And again, if you look closely you can see outperformance in 2022. 

I can't seem to ever recreate the results with funds however. I couldn't recreate the above result. I pretty much go through the same exercise when I see different models that have large weightings to managed futures and I can't get there. It could be me, clearly. But it also could be that it can't be recreated using brokerage accessible funds and that is probably the only way most of us can access the strategy. 

A 5% weighting to a managed futures fund that goes up 20% in a year like 2022 adds 100 basis points of positive return to a portfolio's result. As opposed to using leverage to add the 5% (in my example), if that 5% avoids exposure to something that goes down 15 or 20% (AGG or SPY) then the portfolio is spared another 75-100 basis points of negative performance. When you need managed futures the most, you don't want full equity exposure like in a portable alpha strategy, you want less, managed futures tend to go up when stocks are going down even if that is not infallible. 

Barron's wrote about a survey showing that 94% of advisors believe they don't own enough alternatives while 57% said they don't know enough about them. The context was mostly private equity and private credit but not exclusively I don't believe. My use and our conversation started before the word alternatives started being used. For anyone willing to make the time to learn, prudent use of alts, not 20% in one type of alt, I think they can make adverse market events much easier to endure. 

The information, analysis and opinions expressed herein reflect our judgment and opinions as of the date of writing and are subject to change at any time without notice. They are not intended to constitute legal, tax, securities or investment advice or a recommended course of action in any given situation.

You Have To Figure It Out For Yourself

Tadas Viskanta wrote a post titled Everyone Is Running Their Own Race. Included in there was "the more decisions we make, the most chances we have to mess up" which I find to be a great way to articulate what we talk about here in terms of letting the stock market's natural tendency to move from the lower left to the upper right work in your favor. The fancy word for this inertia is ergodicity. 

In client portfolios, I have quite a few names that I've owned since I started in this part of the business more than 20 years ago and quite a few others that have been in there more than 10 years. I believe the best way to manage a portfolio is to maintain a nucleus of core positions and then make more regular changes around how I dial up or dial down the portfolio's equity beta using the various alts we regularly talk about. Occasionally of course, changes to the nucleus need to be made but when you look at a long term chart and say I wish I would have just held it, that's my race, to put it in Tadas' terms. 

Weaving in an article from Yahoo about Americans flunking a six question retirement quiz, "most respondents bombed big time" the article said. Beliefs about retirement are our own race, our own thing to figure out for ourselves. We all know people who retired at 50 versus a video my wife was telling me about, a furniture upholsterer who is 94 and still works in the same shop that he and his wife have owned for 47 years. We all know people very well prepared for retirement and people who would appear to be in a lot of trouble. We all know people who make a full time gig out of planning and managing retirement and others who give it zero thought whatsoever. It's our own race. 

The article touches on decisions about Social Security noting that most people don't know they should wait. Should wait is not the correct framing. What matters far more, is making an informed decision about waiting or taking it late. A friend turns 58 this month and in four years she can take the early payout. Her husband works. I think they each make enough that they would be best off each taking their own payout not one taking the spousal. 

Taking their example and making it more general because I don't know about their particulars beyond this point, if she really dislikes her job, maybe she should retire at 62 and start to take SS while her husband who might like his job continues to work. We all run our own race and there is nothing wrong with taking advantage of some flexibility if you can. Maybe my friend, or switch it around to her husband not liking his job, can retire at 62 and with the safety net of knowing he, or she, could take Social Security, can figure out how to monetize something else to maybe push back Social Security. 

Another friend is going through something very serious with a medical thing. I can see where this sort of event might cause someone to decide to retire, life is too short and so on which would be their race, perfectly valid. I was sick for a year as a kid and for me, my race was to keep every aspect of my life as normal as I could possibly make it and I don't believe that has changed, that would be my race and perfectly valid. 

There was a quick but thin mention of what's your (retirement) number? I would reiterate the point we've been making here forever which is that having a number of some sort along with some understanding of what that number can or cannot do is important but whatever your number was, it has no relevance to what you end up with. Who cares about a $2 million goal when you end up with $1.3 million. Spending 4% of $2 million when the account balance is $1.3 million is probably going to end badly. 

There are a few comments on the Yahoo article noting how poor the education system has been at teaching personal finance. I do not know the extent of how bad or good it has been over the last 40 year or so since I graduated high school. I remember one project in sixth grade where we all picked a stock but that's it. If the Joe Moglia quote I throw around about no one caring more about your retirement than you resonates, then it is incumbent upon us individually to learn what we need to in order to have a successful outcome. 

An important thing to learn is what to avoid which we'll close out on regarding the spat on Bloomberg between Michael Saylor and Jim Chanos, they were interviewed separately. Chanos called what Saylor is doing with issuing convertibles and now preferred to buy more Bitcoin financial gibberish. 

Saylor very calmly replied that what Chanos doesn't understand is that Strategy is "actually the largest issuer of bitcoin backed credit instruments in the world." Ok, um that's something Saylor made up along with the term Bitcoin yield. He went on to say they "borrowed money that we never need to pay back." There are a couple different ways we could go with that one. He was asked something about Bitcoin going down and he pretty much said it wasn't going to go down but spelled out some more financial gibberish about why that would be ok for them too. 

The risk here is enormous. If Bitcoin keeps going up and never trades below $100,000 ever again then there may never be a consequence for all the risk embedded Strategy's common, the converts and the preferreds not to mention the ETF ecosystem of MSTR funds but the risk is absolutely there and it is enormous (repeated for emphasis). 

I'm not sure what happens to Strategy if the road from here to $1 million (Tom Lee said $3 million) goes through $40,000 and it languishes at $40,000 for a couple of years and of course it could all turn out to be bullshit. People love volatility on the way up. For my money a little Bitcoin has plenty of volatility. Speculating on it with a relatively small dollar amount is my race, not the 3 or 4 x leverage of owning MSTR. If that is your race, by all means. 

The information, analysis and opinions expressed herein reflect our judgment and opinions as of the date of writing and are subject to change at any time without notice. They are not intended to constitute legal, tax, securities or investment advice or a recommended course of action in any given situation.

Too Clever By Half?

One of the biggest themes we focus on is simplicity versus complexity, knowing when to use the former (more often than not) and when to use the latter. Here's an interesting read about Yale trying to sell a bunch of complexity because it believes it has to as a response to threatened cuts in federal funding. 

There's a never ending supply of complex products and strategies for us to dissect and that really is a lot of fun but there is utility as well. A lot of simplicity hedged with a little bit of complexity as I talk about portfolio construction means taking the time to sift through the complexity and recognize when a fund might be too clever by half.

To that end, I wanted to try to better understand the potential utility of the Pimco StocksPLUS Absolute Return Fund which has a bunch of symbols but we'll use PTOPX. The fund uses leverage to access 100% in equities and 100% in absolute return similar to the newer ReturnStacked suite of ETFs.

As a core holding, I'm not sure there's really any meaningful differentiation versus 50% in the S&P 500 and 50% Vanguard Market Neutral (VMNIX). Putting 100% into PTOPX is there for context and not something that too many people should consider.

And maybe not much that is compelling about the fund as a complimentary holding either. The following from the Fidelity page seals it for me. 

It has been a while since it was additive to a portfolio performance-wise.

And because it is sort of related, Paul Tudor Jones was on Bloomberg this morning talking about constructing a "volatility adjusted" portfolio comprised of stocks, gold and Bitcoin. The new ReturnStacked US Stocks &Gold/Bitcoin ETF (RSSX) does a variation on this. 

Corey Hoffstein Tweeted a formula of 100% to stocks, 80% in gold and 20% Bitcoin inline with what RSSX does to create Tudor Jones' trade. Unlevered you could cut those in half. I asked Copilot how to do this and it said stocks 40-50%, gold 30-40% and 10-20% in Bitcoin which is essentially what Corey said. When I play around with it on Portfoliovisualizer, I get 50% equities, 44% gold and 6% Bitcoin.

I've been very skeptical about the ReturnStacked funds. Anytime I play around with them, I never get a compelling result with them. After just two weeks of trading, there is no conclusion to draw about RSSX. It is of course interesting but I personally am very wary of this type of complexity.

The information, analysis and opinions expressed herein reflect our judgment and opinions as of the date of writing and are subject to change at any time without notice. They are not intended to constitute legal, tax, securities or investment advice or a recommended course of action in any given situation.

Don't Do This x 2

Early this morning Matt Miskin from Manulife was on Bloomberg and part of his commentary talked about his belief that quality stocks, as in the quality factor, are underappreciated and undervalued because, he said, they are underperforming this year.

GMO Quality ETF (QLTY) and iShares Quality ETF (QUAL) are the two I look at for blogging purposes as proxies for the quality factor but I think buybacks and shareholder yield are also quality-ish too. On the chart, obviously one is a little ahead of the S&P 500 and one is a little behind. Miskin could end up being exactly right that quality will outperform, I have no idea, and of course if you want to own this factor, go for it but the odds of gaming one factor correctly at the expense of another one are very stacked against you. 

The more likely outcome is chasing last year's best performing factor which will quickly drift into those studies you see that show fund holders lagging far behind the funds they own due to poorly timed trades. I've got nothing negative to say about the quality factor but chasing heat is a self-imposed impediment to successful outcomes, just don't do this.

I listened to another Spaces event on Twitter about YieldMax funds. I was not moved to view them as anything other than a curiosity or more correctly one step on a path to the crazy high yielders in the derivative income space maybe becoming more useable. Or not, I don't know and that is the point.

The Spaces was a good format for letting listeners asked questions. One listener said he was older and a big fan of the product. If I understood correctly, he made it seem like this anyway, he has all his money in a Roth IRA split between five different YieldMax ETFs. He mentioned having NVDY, TSLY, MSTY, one for Bitcoin and I missed the 5th one. Early in his comment, one of the moderators asked "you have a basket of them, you don't just have like two of them?" Again he had said his entire Roth is in them. It was at this point he said five and then named them. I think I could hear the moderator wince a little bit but maybe not. 

We don't actually know if his Roth is the guy's only account, it just seemed like it, but he was clear that his entire account is split between five YieldMax funds. Don't do this. You could stop reading here and that would be the message, do not do that. I have no idea what kind of top down market malfunction would take down this niche but if that unknown malfunction ever happened, this guy would be penniless. Or, if there was ever some sort of problem unique to YieldMax but not the rest of the derivative income space, this guy would be penniless. 

That is a similar line of thought to not owning too many funds from a provider like AQR. There is carryover of the same/similar trades and positions across multiple funds. The risk would be some trade goes really wrong and many funds are impacted. 

The information, analysis and opinions expressed herein reflect our judgment and opinions as of the date of writing and are subject to change at any time without notice. They are not intended to constitute legal, tax, securities or investment advice or a recommended course of action in any given situation.