The framing for this could be thought of absolute return trying to get CPI plus some amount. A real return of 2% is generally a benchmark for these sorts of things. Plain equities of course have a much higher real return and also much greater volatility than absolute return.
The funds in Portfolio 2 were chosen so that we could get a pretty long period to study. There are of course far more sophisticated strategies available in retail accessible funds now with daily liquidity. This concept might be for someone who is ahead of where they need to be but still needing a decent real return in case price inflation does something squirrelly while avoiding the volatility that goes with a "normal" allocation to equities. Interestingly though, based on equity beta, 10% in TECL would be like having 40% in the S&P 500. Sort of. I wouldn't assume that to be a linear relationship but it speaks to this form of capital efficiency providing a decent percentage of net equity exposure with very few dollars at risk.
With that longer term context, here's a shorter period that takes advantage of some newer funds.
For this period, inflation compounded at 3.99%. I used SHRIX for catastrophe bonds. That big dip in late 2022 came from Hurricane Ian. The market reacted like there would be big payouts but there were actually no triggering events.
Of course, if I ever wanted to actually implement this anywhere, I'd divide the 90% not going into TECL between a dozen different things to avoid the idiosyncratic risk of having 90% in one strategy. I would want to avoid the idiosyncratic risk of having 20% in one strategy let alone 90%.
If you're wondering what the hell Cliffwater is doing there, that story is evolving inside of the bigger private credit story. Bloomberg did a very deep dive into the funds and the structure of the company itself.
The big takeaway for me is the complexity of both the funds and the company. There was no wrongdoing implied and for that matter no poor investment decisions either. They're heaviest in loans to tech companies but so is the entire industry and actually the percentage isn't so big that you'd think yikes, why so much.
In a recent blog post mentioning Cliffwater and private assets I quoted someone as saying "no one wants to be the last one out" which seems more like what is going on. A lot of people want out at once, most funds are structured to only let 5% out every quarter and the requests for redemptions are generally exceeding the 5% caps. Cliffwater is not immune to this. Against that backdrop, if these funds need to sell and are then forced to sell to discounted bids, it can hurt fund NAVs and reduce the amount that customers get from selling. This can all happen without the actual loans going bad.
I included Cliffwater above is to show that the issues that go with illiquidity, lack of price transparency and the expense may not justify the returns. The returns have been good but are they so good as to justify the drawbacks of the interval wrapper? We found a couple of things that have been doing a little better than Cliffwater and there will be plenty of others not doing quite as well but pretty good all the same.
Back to our capital efficiency strategy. Copilot did not like the idea of putting 10% in TECL. It made an interesting point, that with the goal of absolute return and a CPI-plus sort of outcome, no single holding should be able to take more than 3-4% out of the entire portfolio. I countered with adding 15% in BLNDX with 5% in TECL. After some back and forth, we came up with this;
Comparing it to 10% TECL/90% T-bills.
As is often the case with these, I would not focus on the performance versus VBAIX, it is a short period to study because of how long some of the funds have been around. Part of why so many of the portfolios we look at have done better is not what we add, it's what we avoid which of course is bond duration. The volatility info and portfolio stats have more information than the growth rate. The portfolio we created today has less than 25% in equity exposure so of course it will lag behind VBAIX with more time to study but the ride for this portfolio can be much steadier and be CPI-plus.
I'd add that the portfolio we built for today's post is that it violates one of our bigger picture goals which is a lot of simplicity hedged with a little complexity. This is a lot of complexity. It diversifies the risks but it is absolutely not simple.
One thing about trying to use Copilot is that it tends to give a heavy weighting to the worst possible thing happening to each strategy at the same time in manner that would be unprecedented. Using AI is very helpful but learning how to challenge the outputs is important too.
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.
No comments:
Post a Comment