Skewing To An Unrealistically Good Result

All sorts of fun stuff today but no post yesterday because we had this going on. 

Two fires in three days doesn't happen here very often. I was first on scene with another firefighter. We knew other resources were coming so the immediate objective was to try to prevent it from getting worse and start to knock it down. Despite what it looks like, I am not directly under the power line.

We'll kick off with comments that Ken Griffin gave to Bloomberg, he said that diversification is the most important thing for newer investors because "your likelihood of beating the pros as a novice investor is low." I would argue of course that "beating the pros" is the about the last thing any investor should worry about, new or otherwise. 

Here's the one thing, with regard to portfolio outcomes, that matters most. Do you have enough money when you need it, for as long as you need it? That's it. Dusting off an old one, quick, without looking, what did the S&P 500 do in 2017 and did you outperform or lag? That odds that anyone knows without looking are microscopic because it doesn't matter. If you're 50 and only have 1/3 of what you should have by now, you're not going to outperform your way up to where you should be. If you're 85 and very fit but out of money, whether you outperformed from 1990 to 2000 means nothing. 

This is part of the reason we spend so much time here trying to figure out how to make the ride smoother over the long term. A very volatile portfolio increases the likelihood of panicking or making some other behavioral mistake. 

On Tuesday, I sat in on a webinar from ReturnStacked about the newest ETF that leverages up to own stocks, gold and Bitcoin that has symbol RSSX which we've looked at a couple of times. I won't bore you with more about that fund but they made a high level characterization of their strategy that I thought was interesting. Most of their funds they said offer a very basic asset class with an alternative added on top. The benefit as they see it is when deciding to use alts, you have to figure where to take from, stocks or bonds, to add the exposure. So 60/40 might become 50/30/20. With their funds, it can be 60/40/20.

The AQR fund QSPIX is the sole alt in portfolios 2, 3 and 4. I chose QSPIX because it has been around for a while and doesn't have a return that is so good that it might not be repeatable. And despite the so-so CAGR, it appears to have been an effective diversifier over the years. 

Looking at portfolios 3 and 4, the leverage gets you nothing. It lagged by a basis point so ok, it's a push and Portfolio 4 was a hair more volatile. Maybe it is something about my method but it is difficult to put something together using retail accessible funds to get their concept to work. I go through this so often trying to find a compelling result and it is just hard to do. 

In a similar vein, Simplify posted a paper in support of some of their alt funds. They tilted to 50/30/20 but they made a useful point about needing to discern between alts that actually offer differentiation versus equities and fixed income. Private credit is often considered an alt but they question private credit's usefulness as an alt. Maybe some private credit fund you might access will outperform regular credit or maybe not, but there's not a lot of differentiation. 

The paper highlights their managed futures fund, the new currency fund with symbol FOXY, their commodity fund and the new high yielding fund that uses something called barrier put options, symbol XV. Taking the 20 in the 50/30/20 and dividing it up equally with similar, but older funds and building out a 50/30/20 with the following.

So there is some differentiation. This 50/30/20 lags a little is a little less volatile, it did noticeably better in 2022 but not the other drawdowns.

What I built though may not be fair to Simplify. Their currency fund FOXY might end up being much better than CEW. Some of the Simplify funds do fantastically well and FOXY could be one of those but obviously at this point there is no way to know. 

We'll close out with a couple of new funds. I've mentioned client holding Alpha Architect Box ETF (BOXX). It is long and short S&P 500 calls and puts in such a way that the return mimics the yield on T-bills without owning T-bills. The much newer Twin Oak Short Horizon Absolute Return ETF (TOAK) appears to seek the same outcome with a slightly different option strategy. TOAK appears to be long a couple of straddles but not short any options. 

I threw in client and personal holding MERIX for a little context. MERIX is essentially a horizontal like that tilts upward yet it looks far more volatile than BOXX or TOAK. I own BOXX for clients to have a little less direct Treasury exposure in case there is some sort of unforced error with something like the debt ceiling. To be clear, I am not worried about the US being unable to pay it's bills, more like congressional dysfunction leading to something stupid. If a strategy like BOXX or TOAK interests you, I would not own both, I believe they are too similar to own both. 

Finally, WisdomTree launched a new capital efficient (leveraged) fund that focuses on inflation, the WisdomTree Inflation Plus (WTIP). The breakdown is 10% cash for collateral, 85% in TIPS, 5-10% to Bitcoin and 95% in commodities of which, 15% is long gold and silver. The other 80% of the commodity sleeve can be long, short or flat energy, metals, grains and softs based on momentum. 

Trying to backtest the WTIP allocation might not be too helpful. If the results of Bitcoin are not repeatable, it going up 10x would be less of a gain than looking backwards, then any sort of backtest will skew to an unrealistically good result. 

Capital efficiency is of course a fascinating method (I think it is anyway). I don't employ it with traditional leverage. If I do anything with it, it is with leveraging down as we have described it before with a small allocation to BTAL as more of a long term hold and a couple of others that are a little more tactical. We're seeing more fund providers start to offer capital efficient funds. This is something that would be easy to misuse or otherwise get wrong. Relative to the providers out there, I  think WisdomTree has it pretty dialed in as far as funds meeting expectations.

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