High Volatility!

We have a lot of ground to cover today involving volatility and portfolio construction. The starting point is a podcast featuring Jeff Park from Bitwise. Jeff has some interesting takes on some topics but there is also a fair bit of sifting required to get to the good stuff. Where the utility came in was taking a second order effect from what he was saying. 

Keeping in mind who he works for he had some interesting things to say about meme coins, aka shit coins that on the surface appear to be nothing but devices for gambling. He didn't make the case that meme coins are somehow not just about gambling but that there is a way to have an information advantage as a function of time spent understanding various types of technology. He equated the manner in which some people play this market as being more about skill akin to poker, than gambling that requires no skill like slot machines. He acknowledged there are plenty of people just speculating on meme coins with zero understanding.

An information advantage also applies to individual stocks and various private equity and private credit opportunities that are becoming more prevalent. Using Jeff's idea, I assume no information advantage where private equity and private credit is concerned which is why I would urge caution. A small allocation to a vehicle offering private whatever, ok, maybe it works out, maybe not but the consequence for being wrong won't be disastrous. I would just be aware that with some of these pools, someone is going to be the last sucker. 

Another interesting point by Jeff about meme coins is that yes, a lot of them (most of them? all of them?) do go to zero. So too though do many stocks, look up survivor bias, but with meme coins it happens faster. 

Is that already happening with the Melania coin that came out a week ago? I have no idea, I realize I have no information advantage here. The screen shot is from a post on Bluesky. Is Walgreen's on its way to zero? I don't know but it's been on a long slow ride down 85% and plenty of blue chip type stocks have disappeared or are shells of their former selves, Kodak anyone? 

A last point about meme coins that resonated was that trading meme coins can be fun (that's Jeff talking) and so you could think of it as spending money to do something fun. That is very similar to what I've said about buying an expensive collectible or a fraction of an expensive collectible like a baseball card. If you want to throw $1000 toward fractional ownership of very expensive card, go for it, but I would think of it as spending money not investing it. If you get a return, cool, but if you love baseball then owning a small piece of a $980,000 card seems like it would be fun and maybe someone else would get that same enjoyment from some sort meme coin.

A little more broadly, Jeff quickly shared thoughts on constructing 60/40 portfolios drawing a similar conclusion to me about bonds' diversification benefits. I didn't take him to say don't own bonds, more like they no longer offer the diversification benefits they once did. He talked about 60% into more typical holdings (stocks and bonds) and then 40% into truly uncorrelated assets like various forms of crypto and he specifically also mentioned litigation financing. 

Ironically, this review of Nouriel Roubini's new Atlas America ETF (USAF) in Barron's quoted Roubini as saying almost the same thing as Jeff about bonds' diversification benefits. 

The 40% as Jeff seemed to be framing it, took me to thinking about allocating to volatility or as you'll sometimes read about it, as harnessing volatility. This is intriguing to me, all of our conversations here about barbelling volatility seem relevant to this post as crypto and meme coins are about how to introduce volatility into a portfolio in such away that it doesn't cause real damage. Yes, the image I made below sucks but like many different exposures a portfolio could take on, volatility used prudently can help with risk adjusted returns or used imprudently could cause absolute carnage.

Over the last year or so, there's been an onslaught of new ETFs that one way or another provide access to harnessing volatility and, because I think it is related, funds offering access to asymmetry and this year the list of filings and actual new funds seems to be growing at an exponential rate. Check out ETF Hearsay's feed on Twitter to see what I mean. 

Yesterday, there was an avalanche of filings for Ripple, Litecoin and Bitcoin adopters ETFs, leveraged and inverse versions of those funds and even more funds that blend crypto and derivative income. That latter could arguably be both long and short volatility which is an idea we've looked at before. 

There is clearly a mania going on here. With all the dollars involved, it is probably big enough to be a bubble but right or wrong, I am not convinced that the percentage of Americans that own crypto is as high as a Goggle search would tell you. If I'm wrong, I'm wrong. 

I flat out believe that volatility when used correctly can be additive to a portfolio, same with asymmetry but I would be concerned about something bad happening in this volatility space (derivative income funds "yielding" 60%) or as part of the same event, something bad happening with asymmetry as applied to the crypto space or levered, single stock ETFs.

If you would normally put 5% into one stock and instead you put 2.5% into a 2x fund with the rest of that 5% in cash, the daily tracking of that 2x fund may or may not be problematic but you wouldn't be doing yourself in versus putting that entire 5% into a 2x fund, essentially taking on a 10% weighting. The former is leveraging down and the latter is leveraging up.

I wouldn't dismiss all of this out of hand though. If the idea of barbelling asymmetry into a portfolio holds any appeal to you, I do think this is valid, how much would you allocate to asymmetry? If you have $1 million in markets, maybe dialing down the Nassim idea of 10% into very risky holdings, what about 5%? Putting $50,000 into just one risky exposure with asymmetric potential may not be very comfortable but what about $5000-$10,000 each into a handful of ideas? If that makes sense, ok but putting $10,000 each into Bitcoin, XRP and Microstrategy sounds like loading up on the same risk. That's part of the reason why we talk about the importance/benefit about taking the time to learn at least a little about many of these. I don't yet really know anything about XRP but it probably makes sense to dig in at least a little. 

In building an asymmetry sleeve, if you want to go as big as 5-10%, 10% is a no for me but I could be talked into 5%, spread it around with maybe a little in crypto, maybe some in AI (beyond the Mag 7), quantum (dig in and you'll see it's different than AI) a lottery ticket biotech and maybe a hole in the ground with a liar standing over it, oops I mean some sort of unproven mine just as examples. 

We also have talked about barbelling yield which is where selling volatility can come in. There are really a lot of derivative income funds (repeated for emphasis) and I would not go heavy by any means but as an example we've gone over before, an account looking for a 4% withdrawal could get half of that from a 5% allocation to a couple of crazy high yielders, all the better if any of the "yield" is actually return of capital which is sometimes the case. The growth from the rest of the portfolio could offset the price deterioration of the crazy high yielder. This is also a path to nudging up the income taken by a percentage point or so but notice, we are talking a very small allocation in case something goes wrong.

A lot of the derivative income funds have real issues but I think we are moving toward a usable product. I don't know if there is an XRP derivative income fund in the works but if there was, it would be a product that sells XRP's volatility, not a proxy for XRP.

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