Keep It Simple And Diversify Your Diversifiers

For awhile, I've been seeing that Calamos has a suite of Bitcoin protection ETFs, so like defined outcome or buffered. Where I always say just don't with the buffered ETFs I haven't looked into them at all but the following popped up on my Twitter feed, yes I am still calling it Twitter.

I will take the perspective that most readers are curious but not true believers. If you fall into that camp, that's where I am, then capping the upside makes no sense. If you're a true believer, I'd bet you have more actual Bitcoin than investable brokerage products. At a market cap of $2 trillion +/-, it is nowhere close to big enough to do what the true believers think it will do. 

A 55% gain does nothing toward becoming a solution for anything. A 10x gain from here probably isn't big enough to do everything the touts are calling for. Call me at 20x from current prices. I'm not saying it will happen. I doubt it will and I doubt it will evolve to solve any problems. But it could go much higher while failing to solve all the world's financial problems and I am along for that ride. I'm way up on most of what I own and at $700k-$800k per Bitcoin, that might be lifechanging money for me as I have referred to it before. 

Buy it or don't buy it, I am not here to talk anyone into speculating on this but if you are going to dabble, at least do it for the right reason and the right way and capping the upside is wrong on both counts. 

Writing for ETF.com, Allan Roth tried to get readers to remember what it feels like when equities go down a lot, 40% in his made up scenario. There will obviously be future bear markets and the extent to which they cause real damage to a financial plan depends on whether any steps are taken to mitigate the full brunt of a decline that. It's very simple. Have some number of month's worth of expected expenses in cash or cash proxies and have some of the portfolio allocated to first responder defensive holdings, like BTAL for me, and some of the portfolio in second responder defensives like managed futures. BTAL and managed futures are just examples, they are not the only ones. Bear markets typically last 18-30 months which could serve as a guide for how much cash to set aside. 

Speaking of managed futures, Institutional Investor had an article about using managed futures (MF) as part of a portable alpha strategy pointing to MF as the best tool for portable alpha. There wasn't much that was new but there were some interesting comments toward the end from Razvan Remsing about investors not wanting to allocate too far away from equities for fear of missing out on returns. This makes sense to me as equities are the thing that goes up the most, most of the time. By adding MF on top of equities as the basic argument for portable alpha goes, you don't give up the equity returns of a full allocation, whatever that might be, and you get the diversification benefits of MF.

Yes, equities are the thing that goes up the most, most of the time but it can also be true that managed futures have excellent diversification benefits in the form of crisis alpha. A common allocation for portable alpha implementation (per what I've read) is 30% into some sort of alternative strategy, managed futures for this post, so I played around with it on testfol.io using leverage, versus not using leverage and T-bills versus the more common AGG bond benchmark.

Both unleveraged versions had very smooth rides with a real return, meaningfully above the rate of inflation. In 2022, the two unleveraged versions were down 66 basis points and up 3.56% respectively while the leveraged version fell 6.87%, a great result, while plain VBAIX dropped 16.87%. Both unleveraged versions were down 800-900 basis points less than the others during the 2020 Pandemic crash. 

The history of managed futures zigging when stocks and bonds zag, has been pretty reliable but of course the risk is that in some future event, managed futures also go down a lot. You implement something close to what the II article talks about, heavy into managed futures, back to Roth's article where stocks drop 40%, what if managed futures drop 30% at the same time? It's unlikely but not impossible for some sort of unpredictable, awful coincidence to take them both down together. It would be even worse if leveraged was used to build up the managed futures position. 

We can use the WisdomTree Core Efficient Portfolio (NTSX) to easily model a more modest 5% to managed futures. NTSX is leveraged such that a 67% allocation equals 100% to VBAIX.

The 5% weighting to managed futures helped by 167 basis points in 2022. If managed futures had cut in half, that big of a decline may not be possible but still, then it would have been a 250 basis point drag in this example versus 1500 basis points at a 30% portfolio weighting. 

Keep it simple and diversify your diversifiers. 

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.