Implementing The Cockroach?

Jason Buck from Mutiny Funds sat for Meb Faber's podcast. We've mentioned Jason a couple of times this summer, most prominently in this post about a portfolio concept they came up with called The Cockroach Portfolio. The podcast was wide ranging and also hit on a couple of more nuanced points about Cockroach.

One point that resonated, because I've been making a similar point pretty much since I started writing, was about investment professionals like RIAs or fund managers not investing in stocks or at least not investing a lot because, as I've framed it my livelihood is very leveraged to ups and downs of the stock market already. Being older than both I probably made this observation before them but I make no claim of originality, I would say it's a very obvious point. I've maintained about a 25% allocation to equities forever. I have zero desire to retire, but probably could if my hand was forced somehow and 25% is nowhere near whatever my pain tolerance is so it's very empowering. Add on top of that I love the work. 

Meb brought up his standing offer to manage endowments/pensions like CALPERS for free. He said they are way too complex, he'd just build them a simple ETF portfolio an then rebalance a couple of times per year. Contrast that with Jason where the Cockroach idea can be simple but his implementation seems very complex, he talked about having 14 different managers just for the volatility portion of the portfolio. 

As I mentioned before, The Cockroach Portfolio is influenced by The Permanent Portfolio. In its full levered implementation, Cockroach allocates 50% each to global stocks, global bonds, long volatility and trend (aka managed futures). Then there is another 20% to gold/crypto for a total leverage of 2.2x. Jason noted that leverage is prudent when it blends lowly or negatively correlated assets or as we've talked about here, leveraging down. 

I want no part of that kind of "prudent" leverage. My idea of leverage is something like 70% equities instead of 60 because you get far more protection from VIX and tail risk funds because of their negative correlation than from bonds. VIX and tail risk are likely to go up when stocks go down versus bonds just not going down. Until this year anyway.

Paraphrasing, Meb asked how to implement Cockroach in a retail account. Jason said 50% in a 60/40 mix so let's go with Vanguard Balanced Index Fund (VBAIX), 25% in trend where we will continue to use Guggenheim Managed Futures (RYMFX) and 25% in long volatility which could be a VIX fund or a tail risk fund but lets go with client holding ProShares VIX Medium Term Futures ETF (VIXM). There was no mention of anything to gold or crypto for the retail version of it. 

 

Portfolio 1 is as Jason described, Portfolio 2 is a tweak to be much closer to a "normal" allocation to stocks and bonds and Portfolio 3 is 100% 60/40. Here are the results.

  

The balanced risk approach the Jason was talking about lagged far behind with a 1.46% CAGR but somehow it had by far largest max drawdown. Of the 10.5 years studied, there were 4 where Portfolio 1 was down slightly in an otherwise up market. At some point, Jason mentioned generational wealth kind of  like the Dragon Portfolio we've looked at a couple of times. Again I will ask, is generational wealth your objective? Not leaving money to your kids, I mean wealth for successive generations, plural. If not, then Cockroach as laid out wouldn't be suitable. 

Portfolio 2 on the other hand is interesting in terms of smoothing out the ride. It pretty much didn't go down in the 2020 Pandemic Crash and YTD it is down 7.75% versus 14.55% for 100% VBAIX. I would note that Portfolio 1 is down 0.95% this year but that really is a lot of cumulative lag for Portfolio 1 over the full period studied. 

Very obviously, the way Jason actually implements this is different and I am sure, superior. Even if you're in game over mode, you can still be too defensive. It is easy, after a lousy run for equities or in this case equities and fixed income, to want to forsake a normal allocation to equities but that is a mistake for most people. I have no idea when the current market event will end but it will end and then stocks will go up and make a new high. Maybe that will come soon or maybe it will take longer than we'd like but it will happen. 

Smoothing out the ride doesn't mean no equity volatility, it means less equity volatility. Too much allocated to defensive, negatively correlated exposures and your account won't grow. If you're relying on some measure of equity market price appreciation then 50% in defensives is too much.

But as I've been saying for years, just because I disagree with the end product, there is influence to be had. Using volatility as a tool to protect a portfolio using smaller sizing makes sense to me. Using trend as a tool to protect a portfolio using smaller sizing makes sense to me and as we've seen recently, there are some managed futures funds out there that have been around almost as long as RYMFX but with much better results. Holding a managed futures fund, again much less than 25%, with a CAGR of 4 or 5%, and they're out there, is much less of a drag than RYMFX with a CAGR barely above 1%. There are no guarantees about future outperformance but it might be reasonable to conclude that lagging for 6 years or 7 or longer might reasonably mean the fund is inferior.