Can I Interest You In Lagging The Market By 5% Almost Every Year?

Phil Pearlman Tweeted out the following.

The bigger point is of course about how simple some things can be. That feeds into this from Rick Ferri.

We looked at something similar even if less extreme with an 18 fund model that maybe could have been replaced by a two fund model. I do not think a two or three fund portfolio is optimal but it is valid and I think it is hard to justify some sort of model with a lot of funds that results just like a 60/40 mutual fund like Vanguard Balanced Index Fund (VBAIX).

Portfolio 2 is plain vanilla 60/40. Portfolio 1 swaps out the aggregate bond fund and replaces it with two different funds, still quite simple but it changes the volatility profile dramatically. 

Obviously not everyone would be willing to give up the incremental return for a smoother ride and smaller drawdowns (I am not being snarky) but for anyone willing to make this trade off, I would describe Portfolio 2 as a simple buildout with a not so simple outcome. The blending accomplishes a sophisticated outcome. BTAL is a client and personal holding.

The following three ideas blend barbelling returns and the RISR/MBB pair trade we've looked at over the last few days.

As we looked at the other day, technology as represented by client holding IYW tends to go up more than the broad market and it also tends to go down more. The exposure to client/personal holding CBOE attempts to add in a mostly first responder defensive that will hopefully have less drag than BTAL. The small allocation to Bitcoin via BTCFX is an attempt to add asymmetry. I chose BTCFX because it has been around longer than the ETFs.

Portfolio's 2 and 3 try to diffuse the risk of loading up on what amounts to a long/short trade on mortgage backed securities by adding in floating rate and catastrophe bonds. 

In playing around with the different versions, I wanted to see if we could equity like returns with a lot less volatility. Regardless of anything else, there is differentiation between the portfolios and the index. I would argue that none of the portfolios are complex for complexity's sake as Ferri talked about with the 40 ETF portfolio. The results are of course compelling but as we've talked about a couple of times, what is the flaw or the thing to look for? 

I think the great results in 2022 are skewing the entire backtest. All three lagged by a lot in partial year 2021, lagged somewhat in 2023, lagged by kind of a lot in 2024 and this year has been slightly favorable. A 20% weighting to IYW over the last ten years has had 29% upcapture versus the S&P 500 while a 30% weighting had a 41% upcapture so the fund definitely punches above its weight in terms of trying to barbell returns. 

With a longer period to study, I think this idea could get close to being a 75/50 type of result which is a portfolio that captures 75% of the upside with only 50% of the downside. If you run those numbers, you'll see that sort of result would work out very well over the long term but it is very difficult to pull off. From 2010, through 2021, the S&P 500 only had one down year. And of those 11 full years, the S&P 500 was up more than 15% seven times. For a run like that, it might be very difficult emotionally to lag by 5, 6 or 7% year after year.

I think these are valid but they are not without their challenges. 

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