Alternative Expectations

David Tracey opined that "this is the worst market in my life that I've ever seen at pricing in risk." 

Is the equity market mispricing risk? Aren't markets efficient at pricing in all known information? A while back I quipped the markets are efficient except when they aren't. It's funny but it's kind of useless in terms of relying on rational actors in markets. It is useful in terms of pointing out we should not rely on markets always being efficient. Once you can accept that markets will behave irrationally, especially in times of headline stress, it gets easier to keep your cool, to not submit to emotions you might feel.

This contributes to my belief in and use of alternatives to try to manage portfolio volatility. I first learned about this concept back in the late 90's reading about then Harvard Management CEO Jack Meyer investing in timber land, actual timber land not some sort of exchange traded product or REIT, because of its low volatility and low correlation to equities. 

Everyone draws their own conclusions of course but I think alternatives, the right alternatives, properly sized can go a long way to helping smooth out the ride in times of market turmoil like we've been experiencing lately. Maybe for now it's not so much the market that's in turmoil, it's not really down that much, but the world, the headlines, the nature of the unknowns are the source of turmoil. 

I spend a lot of time learning about new (to me) funds and strategies that might help with client portfolios. It's a lot of fun for me but as I have mentioned before, I learn about way more funds than I ever use. For example, I have bee intrigued by risk parity since I first learned about it. I can't quite come around though to being confident in a strategy that balances out risk by levering up on bonds to balance out the risk, to create the parity of risk. With rates so low, even if they stay low the strategy calls for using leverage to buy high. 

This morning I stumbled across a portfolio of alternatives called Return Stacked 60/40 Absolute Return Index. Here's a summary of what they're trying to do: "The Index is designed to preserve exposure to core stock and bond allocations, while bolstering expected risk-adjusted returns with non-correlated return streams like trend following, global macro, and tail-hedging strategies. The Index targets a volatility and drawdown profile similar to a U.S.  balanced portfolio. Of course, there is no guarantee that the Index will meet this objective."

I'm not going to be critical but I don't exactly get what they are trying to do but they have good transparency on the alternatives that comprise their index. Here is a chart of the alternatives in their index YTD compared to the S&P 500 that is down 7% in the red circle.

Some of the alternative strategy funds are up and really don't look like the stock market this year (that's a good thing for an alt) and some are down like the S&P 500, or worse, and have offered no protection. Interesting to me is that TYA, a fairly new risk parity ETF, is down the most at 15.8%. Of course, yields have gone up so a risk parity ETF going down makes sense. But then, what is the value of it as an alt? Maybe there's a better argument for it as a portfolio proxy instead?

Generally, a three month sample size it pretty small but give or take, that's how long the current event has been going on. Zooming the above chart out to four months, the S&P 500 shows down 4.8% with only three of the alt funds charted outperforming and five underperforming. I would note that at four months, the chart for RDMIX appears to be distorted for a large annual payout. 

I disclose the alt funds I use all the time, regular readers know the names. I've lucked out maybe in this event as only one alt fund in my ownership universe has been acting funky, it's not a catastrophe, just not really doing what I'd hope. I don't want to say picking alts is complicated. I mentioned that I spend a lot of time studying these which gives confidence in figuring which ones will meet the expectations they set. There've been a few funds that I have test driven before using for clients, some I end up using like BLNDX and some I don't like SPYC. SPYC is in the Return Stacked index. It owns the S&P 500 with a long strangle overlay (options terminology) to try to smooth out the ride and when I owned it and any time I've looked at it since it just looks like a proxy for the index. I can't see the strategic benefit. 

Taking time to learn and understand does not equate to complexity in my mind but portfolio construction is my primary job so I can give it the time. 

I will close out with what role Bitcoin could play as a diversifier in the context we've been discussing. As someone who owns a little Bitcoin, I would tell you that for now it does nothing. Sometimes it correlates with stocks (risk on) and sometimes it doesn't and there doesn't appear to be any discernable pattern to when it will or will not correlate with stocks or hedge inflation or do anything else but its own thing to eventually either go to a bazillion or go to zero. YTD, Bitcoin has taken a path that at times looks like stocks and other times not and done so with more volatility to arrive at a similar decline as the S&P 500. Of course tomorrow, or any given day, it could be up or down 10% for any reason or no reason. 

This is not an anti-Bitcoin comment, again I own some, but it sets no reasonable expectation for anything in a portfolio. I own it in case the touts turn out to be correct and it does go to a bazillion.