Tontines & The Misery Of Risk Parity Funds

For many of us, the first time we heard the word tontine was in an episode of MASH. There was also a reference to the term on an episode of The Simpsons. It looks like tontines might be making a comeback in a modern application through a mutual fund. The starting point to understand is that it is kind of like an annuity but purports to be much cheaper.

Basically you would buy shares of the mutual fund that you would never be able to sell (there is a version where you could sell some shares though). You can have payments start right away or reinvest to buy more until you want to start taking income. New assets in to the fund and the passing of existing fund holders become potential sources for higher payouts. 

It's moved passed just being an idea, not sure if it will ever come but if is comparable to an annuity in terms of a higher payout than a prudent 4-5% from your own portfolio then it becomes an interesting proposition. If an investor has $1 million for retirement and is expecting $40,000/yr and the tontine kicks out 8%, something like $100,000 into the tontine provides 20% of expected income with only 10% of assets, it presents an opportunity for capital efficiency. Stay tuned. 

There's pending legislation that if passed could be very favorable for retirement savers and retirees in terms of providing more flexibility. The bill would increase limits on IRA and 401k contributions by $4000, put required minimum distributions on a multi-year plan to increase from the recently imposed 72, up from 70, to 75 by 2032 and enhance catch up contributions. At 50, you can put more in to various accounts (55 for HSAs), that would stay the same but then at 62-64 which I guess is still be worked on, you'd be able to contribute quite a bit more to help catch up.

While most of that is fantastic, you might not want to put more into qualified accounts in your 60's. If you have 75-80% of your savings in qualified accounts, or more than that, there is utility to increasing the percentage in non-qualified accounts in terms of meeting nearer term spending needs. Increasing the RMD age to 75 will change quite a few aspects of this part of retirement planning. Obviously any money not put into an IRA loses the benefit of tax deferred compounding. I envision a scenario of spending down to zero the taxable account, save for an emergency fund, letting qualified assets grow and then adding in Social Security closer to 70, or later if they ever lift the age cap from 70. 

I've mentioned several times that I was test driving Rational/Resolve Adaptive Asset Allocation Fund (RDMIX) for possible use in client accounts. As I've blogged about it, I reiterated my concern about it being overly complex. I referred to it as both complex complexity and multivariable complexity. Multi-variable in that it relies on a long list of things working together (my perception, the managers would probably describe it differently). I sold it yesterday, I won't be using it and blogging helped me work through to this decision.

Going too far down the multi-strategy road makes it harder to target a specific outcome for the portfolio. It is much simpler to use single variable complexity, or simple complexity, like managed futures as an equity volatility buffer. Global macro mutual funds are similarly complex as RDMIX, not sure if they ever refer to the fund as global macro or not, with various strategies all going on at once, sometimes canceling each other out like one model in a multi variable strategy saying to go long cotton and another saying to go short. 

It is easy to get intrigued by something that seems so sophisticated and advanced but that can also mean it has more things that can go wrong, Risk parity is another example of this IMO, it just doesn't work in a fund wrapper. If you know an example of one that does work longer term, please let me know.