The Anti-60/40 Portfolio

Corey Hoffstein had a Tweet making fun of Blackrock for lack of conviction for allocating just 1% to some commodity alt (it was not Bitcoin) in model portfolios. Not knowing what the models look like, it would be tough for me to have a strong opinion about a 1% allocation beyond yeah, that might be a little light. Generally though I prefer smaller allocations for wanting to diversify your diversifiers a phrase Jason Buck from Mutiny Capital uses but that I've been writing about for many years. 

As we've been using portfoliovisualizer to build portfolios that offer similar (or even better) results than 60/40 portfolios while avoiding interest rate risk, we looked to alts, they can work, but in percentages that are much higher than I'd ever use in the real world. So in this post I want to try to build a portfolio that does a better job of diversifying diversifiers without giving up too much in the way of risk adjusted return.

The first slide is a portfolio that is more realistic for me in terms of percentages versus the types of portfolios we've blogging about lately as an example and 100% Vanguard Balanced Index Fund (VBAIX) which is a proxy for a 60/40 portfolio.

 

Here are the results going back to 2012.

Portfolio 1 and 2 have shockingly similar results. The CAGRs are only 3 basis points apart and a fair bit better than VBAIX, standard deviations are fairly similar and both are slightly lower than VBAIX. Portfolio 2 fares a little better in down markets but Portfolio 1 has done much better than VBAIX and oddly the Sortino Ratios are identical. 

I would also note that Portfolio 1 greatly deemphasizes interest rate risk and volatility which as we discussed yesterday is an area I want to avoid. I think the results show that it is possible to build a portfolio takes on the attributes an investor would want from bonds, mostly buffering equity volatility.

The tradeoff for three basis points less in CAGR with Portfolio 1, the portfolio is far less vulnerable to one strategy not "working" during some random event. Looking at the alts and the one fixed income fund, they rely on different things so they are vulnerable to different things which is how to diversify the diversifiers. The 8% to MERFX and 7% to BKLN are a little high for my liking but the 2-3% I usually allocate to these things is admittedly quite conservative. 

A quick recap of the alt holdings in Portfolio1; RYMFX is managed futures which pretty consistently looks nothing like equities which means it can go down for long periods of time as is captured in much of the back test for Portfolio 1. BTAL goes long low volatility stocks and short high volatility stocks. it tends to not look like the stock market but occasionally it will not do what investors would hope for. It's reliable enough for me but not infallible, nothing is. VIXM tracks medium term VIX futures. It doesn't track VIX directly but is a decent offset to declining equities. MERFX is merger arbitrage. The performance mostly looks like a horizontal line with a slight tilt upwards.

It is important to understand that a portfolio using only broad based products will not have any home runs. Individual stocks and some narrower based ETFs like for sectors or industries have the potential to go 3X, 4X more what can be had from a broad market index fund. Building a one fund portfolio of VBAIX, valid even if not optimal, or portfolios like 1 and 2 focus more on ergodicity, just letting an intentionally boring allocation work for you over the long term. That's not a bad thing, none of this is bad, it's just an important thing to understand. 

And since we did this in one recent post, here's Portfolio 1 tweaked to take 1% away from MERFX but put it into GBTC. It's a shorter time period because GBTC is a little newer.

 

CAGR goes way up, standard deviation goes up higher than VBAIX but worst year/max drawdown are still much better than 100% VBAIX. Going forward though, Bitcoin could go to zero or go to a bazillion so 1%-ish there seems prudent in case it does go to zero.

Disclosures: BTAL and MERFX are client and personal holdings, VIXM and BKLN are client holdings and one client owns GBTC in a play account on a mandate.