Could Complexity Be Better Than Simplicity?

Torsten Slok blogged about how ineffective bonds have been in terms of providing any return or diversification benefits lately in the context of a 60/40 portfolio. He talked about the need to replace bond exposure and stock exposure too but the point he was making about stocks wasn't too clear to me. He said that "there are years when Treasuries are not the correct hedge against downside risks in the S&P 500" which is a conversation we've been having here for years. 

We talk about several different structures that can potentially replace 60/40 as Slok is referring to it. Some version of the Permanent Portfolio which includes risk parity, lately we've been talking about portable alpha quite a bit and the one that I think is the simplest, and closest to what I do in real life, is getting rid of most or all of the bond exposure and replacing it with shorter dated fixed income that mostly avoids interest rate risk and long bond volatility as well as various types of alternative strategies the might function as bond market substitutes, strategies with some degree of negative correlation to equities or some sort of uncorrelated absolute return ideas. 

Right or wrong, I think of endowment style investing as being a similar to the Permanent Portfolio, not so much quadrants but more like disparate asset class segments which gets us to a paper about endowment asset allocation from True North Institute. 

Based on the following excerpt;

I built out the following leveraged allocation, taking some liberty with shortening the duration quite a bit.

The third portfolio is just the Vanguard Balanced Index Fund (VBAIX). QGMIX is a client and personal holding. These portfolios don't really look anything like what we usually play around with here but the results are interesting. 

Despite all the leverage, Portfolio 1 has a very smooth ride including up a lot in 2022. It's only down year was 2018 with a decline of 7.91%. Both True North portfolios also held up relatively well in the 2020 Pandemic Crash which are the max drawdown numbers in the chart. 

I'm not a fan of leverage but that doesn't mean it can't be used effectively. This leverage in the True North portfolio appears to be effective for giving an adequate return with a very smooth ride as I mentioned. It would take a lot of things going wrong at the same time for this mix of disparate asset classes to have a horrible year, more things going wrong than in a plain vanilla 60/40 portfolio. Maybe this is an exception that proves the rule about simplicity being better than complexity. 

And a quick closing note. One of the Bloomberg pre-market newsletters mentioned the brand new Locorr Strategic Allocation Fund (LSAIX) that we've mentioned a couple of times. The context of the newsletter like today's blog post, looking for bond alternatives for a diversified portfolio. And a couple of tidbits about LSAIX that I picked up. The managed futures sleeve is multi-manager. None of the managers are replicators and the fund can be long and short the same market. For example the fund could be long tin based on one manager's slower signal and it could be short based on another manager's faster signal. The alternative to being long and short the same market would be netting the two out but LSAIX doesn't do that. 

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.