Deconstructing Complexity

We've talked before about the various model portfolios that ReturnStacked ETFs maintains. One of the simpler ones has 20% equal weights to five different funds. It's simple because of the five funds and the equal weight but it is actually very complex for what the funds do. It benchmarks to the iShares Core Growth Allocation ETF (AOR) which is a 60/40 fund.

They call it ReturnStacked Diversified Risk Premia and it owns the following.

• AQR Long Short Equity (QLEIX)
• AQR Diversified Arbitrage (ADAIX)
• AQR Alternative Style Premia Fund (QSPIX)
• ReturnStacked US Stocks & Managed Futures ETF (RSST)
• Simplify Intermediate Term Treasury Futures Strategy ETF (TYA)

I didn't find a look through on the ReturnStacked website to see what the notional exposures are but the model is leveraged up considerably. As of March 31, QLEIX was long 196% and short 169%. It was also long an addition 29% in futures (mostly US equity futures). ADAIX splits between merger arb, convertible arb and event driven. All three are long and short of course but as of 3/31 they were net long. QSPIX is kind of a risk parity strategy in that it is risk weighted long and short equities, commodities, currencies and fixed income. It was 610% long and 578% short. QSPIX is similar to QRPIX which is another AQR fund that we looked at a few weeks ago. RSST is 100% US equities and 100% managed futures. I've seen TYA explained several different ways but in looking at the fund page it has a 300% notional weight to ten year treasury futures which has the effect of extending the duration considerably. As a result, TYA has almost cut in half since its inception in late 2021. 

I modified their portfolio by swapping out RSST because it is so new and replaced it with an S&P 500 ETF and AQR Managed Futures (AQMIX).

The model did well despite how terribly TYA performed. It's still a very short test because TYA only goes back to 2021. The next slide, Portfolio 2 removes TYA and replaces it with iShares Treasury Floating Rate (TFLO) which has very little price fluctuation. 

Avoiding what was obvious interest rate risk adds more that 400 basis points of return per year. For anyone new, I've been writing about avoiding longer duration fixed income for many years. 

The last slide is a longer period thanks to just looking at the TFLO version compared to AOR. With a longer period to study we can see each one has taken turns outperforming. Over the course of 11 full and partial years, the alt-centric portfolio only outperformed five times. The reason the CAGR is so much higher is mostly attributable to 2022 when that portfolio was up 12.7% versus a decline of 15.6% for AOR.

The ReturnStacked portfolio diversifies among many more asset classes/strategies than just stocks and bonds in AOR. The proved out to be more robust in 2022 but not the down year of 2018 when it lagged AOR by over 200 basis points. Looking back, I suppose just about anyone would take that result but there were a lot of years of having to endure weaker, relative returns. The blue line is a better portfolio but it is another example of a portfolio that will be challenging at times to sit with but of course no portfolio can always be best.

In trying to think through different ways to employ what a fund like RSST does into a very simple portfolio. I had one idea that is sort of a game over, someone who doesn't need normal stock growth, but needs to keep up or maybe stay a little bit ahead of inflation type of strategy. 

A 30% allocation to RSST with the rest in a cash proxy might do that. I used Vanguard S&P 500 (VOO) and AQR Managed Futures to get a longer backtest and got the following. 

It clearly does not keep up with 60/40 but that is not the expectation. The leverage means there is 60% notional exposure but only 30% is actually placed into risk assets. In theory, because of the negative correlation between equities and managed futures, RSST should have a lower standard deviation than straight equities but so far it does not. Longer term VOO combined with AQMIX has a slightly higher standard deviation too but the correlation to equities is on the low side.

The worst year for the portfolio above was 2018 when it dropped 3.35%. For most of the back test, there was no yield. Who knows how long T-bills will stay at 5% but yields aren't going to zero. If T-bills had averaged 3%, it would have added about 2.1% in yield to the total return of the blue line result. I also think there is a good chance that managed futures will do better now that rates are off zero. Most of the period available to backtest was during a very dark winter for managed futures. 

Some interesting theory today even if I'm not sure where it will lead us. 

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.