Why The Hell Anyone Would Want To Buy That Fund?

We have a couple of different things to look at today starting with a paper from Cliff Asness. The high level idea was to explore whether markets have become less efficient despite how much more quickly information moves. Things like indexing create a headwind to market efficiency, not I am not saying indexing is the equivalent of Marxism like Alliance Bernstein said a few years ago but I think it fair to conclude that the perpetual tidal wave of 401k contributions and other money flowing into the S&P 500 and Russell 1000 has some sort of impact even if it is beyond us to be able to quantify that impact. It's certainly beyond me to quantify the impact, anyway.

Part of the paper talks about factor investing and I think is implying that there is value in rotating between factors. The quote I'm referring to is "for quants, that’s improving your factors and optimization processes." I don't doubt that he is correct but I don't think the typical market participant should think they have any reliable edge on that front. I've mentioned a couple of times that there used to be cyclical indicators that would be quite a bit better than a coin flip for knowing when to favor size, style and some of the others. Some factors were late cycle versus early cycle, there are some yield curve dynamics involved and a couple of more but, if Asness is correct about markets being less efficient then I suspect that however difficult it had been to successfully rotate between factors, it would be more difficult now. Yes value and dividends did better in 2022 but from the standpoint that "risk happens fast," it is difficult to imagine that a lot of investors rotated into those spaces in a timely fashion in late 2021. 

My take on factors has been that if you're interested, pick one or a blend and stick with it realizing it can't always be best. 

The domino effect is that valuations make no sense versus what investors trained in classical value investing learn about markets and investing. For the record, I do not consider myself a value investor, I'm just trying to convey what I think Asness is saying. 

Here is the money quote for me from the paper. "Do not think you can hide from volatility. It either finds you very painfully eventually or you pay too dearly for the fake smoothness along the way." We spend a lot of time here looking at ways to manage volatility and while we look closely at things like covered call funds and multi-asset funds, I continue to circle back to maintaining the majority of the portfolio in plain vanilla equity beta and diversifying with small exposures to uncorrelated and negatively correlated return streams. 

Trying to build a core around something like a covered call fund is an attempt, as Cliff describes it, to hide from volatility. Core, is not remotely close to being a small, satellite type of position. Adding exposure to something with lower volatility and some yield is absolutely valid in my opinion but not as a substitute for meaningful equity exposure. Part of the fun we have here is looking for ways to blend factors to get equity and equity like result with a little less volatility. Maybe something like a covered call fund could be part of the solution but a portfolio needing normal equity exposure to meet it's objective, 40% or 50% or 60% in a fund that hides from volatility is a bad idea. Maybe even down to 25-30% into a fund like this is a bad idea. 

Next, I wanted to revisit the Alpha Architect Tail Risk ETF (CAOS). The chart compares it to Vanguard S&P 500 ETF (VOO), client and personal holding BTAL, the Cambria Tail Risk ETF (TAIL) and the iShares 10-20 Year Treasury ETF (TLH). 

Yahoo Finance 2.0 needs a little work but the blue, almost horizontal line is CAOS. The rest are a little easier to make out. I threw TLH in there because TAIL is a put option overlay on top of a longer dated treasury bond portfolio. With not much action for the puts this year, it makes sense that TAIL looks like TLH for the most part. TLH and TAIL have a 0.53 correlation. You can see the August dip reflected in spikes in TAIL and CAOS but the spike in CAOS is much smaller. CAOS doesn't really have spike in the September dip although it did not go down on those days. 

BTAL has had an odd year. It has pretty much taken the exact opposite path to almost the same result as the S&P 500. The negative correlation is what it should be doing and it's a pleasant surprise that it is up so much this year. 

CAOS looks more like an upward tilting horizontal line alternative than some sort of fund that can have an asymmetric payoff when things in the equity market hit the fan. TAIL and BTAL come much closer to that outcome than CAOS has so far. When we last looked at CAOS, my working theory/expectation was it would mostly look like it has, with the potential to offer tail risk protection. Holding it hasn't hurt anyone but I think I might expect a bigger reaction from it when the market goes down and maybe the next time something serious happens it will go up more than it did in August.

In the current Barron's, Randy Forsyth checks in on closed end funds as short terms rates have started to go down. David Tepper of Tepper Capital Management is cited as liking the Gabelli Dividend & Income Trust (GDV) because it has a 5.4% and trades at 14% discount. Barron's goes on to say that GDV owns "large capitalization blue chips."

The above comparison doesn't look so hot. A lower growth rate in exchange for some yield is fine but that is a lot more volatility to take on for a much lower growth rate. The next thing to check would be how it did in 2022. That decline will be a great litmus test for a long time still, but unfortunately for holders, GDV was worse than the S&P 500 by 42 basis points. It's a closed end fund. Although the article didn't mention, maybe it's a play on the discount to NAV closing? 

The chart is from CEFconnect.com. They have a wealth of information on closed end funds. They used to do the same with ETFs and in what has to be one of the oddest decisions I've ever seen, they bailed on ETFs ages ago. The site is so much better than ETF.com, I guess they didn't want the responsibility of having 10x more traffic than they get for just CEFs. 

Rant over. Looking at the chart, is there any reason to think that now is the time that the discount will get narrower? I mean you could make that guess but there doesn't appear to be even a coin flip's chance. I don't know why the hell anyone would want to buy that fund. There are plenty of sources of yield with nowhere near that kind of volatility. 

Tepper is not the David Tepper who runs Appaloosa and owns the Carolina Panthers. Funny coincidence, Tepper used to call in to the equity desk at Schwab Institutional when I worked there in the 90's. There's no reason for him to remember but it's always fun when I see a name from back then cited somewhere.

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