You Won't Have WFRPX To Kick Around Anymore

We spend a good bit of time looking at risk parity, trying to see if it can work in a retail accessible fund. There aren't too many of them and they don't seem to work very well. When I say work, I mean do what an investor would hope it would do, I don't necessarily mean accurately track the thing it is supposed to track because most of the ones that don't work are tracking correctly. And looking at the history of the few risk parity funds, it is hard to believe any of them are doing what an investor would hope they would do. 

The Wealthfront Risk Parity Fund (WFRPX) is closing to new money as of 12/27/2024 and expects to be liquidated on January 3rd. It's a $1.3 billion fund charging 25 basis points. The fee seems pretty fair but the performance has been bad, compounding negatively by a few basis points. 

Invoking a recently found term, the risk parity funds seem to be a form of uncompensated complexity. Even RPAR, compounding at 2% in an 8% world for VBAIX has struggled. RPAR has 70% in treasuries although not all of them are long term. You can see on the backtest, RPAR fairing worse than VBAIX by almost 600 basis points in 2022 and then didn't really come back the way VBAIX did.

Risk parity is a good example of a great story. It sounds very sophisticated and that plays to ego, I get it. The funds came out when rates were extremely low meaning prices were high. Leveraging up, which it what risk parity does, it leverages up on bonds, when prices are close to or at all time highs is very risky and it turns out, there were serious consequences for that risk in 2022. Before then, RPAR tracked VBAIX pretty closely. WFRPX did well in 2019 but lagged VBAIX by a lot in every other year of its existence. 

It is easy to get carried away with overly sophisticated strategies bundled into funds. I believe in these conceptually but I think it is important to keep exposures small, be appropriately skeptical and diversify your diversifiers. 

On a personal note, I've been particularly busy for a few days, nothing bad, and hope resume normal blogging shortly.

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.

Carry On Wayward Fund

ReturnStacked ETFs added some very interesting info to the pages for its ETFs. They are now providing transparency on risk weighting of the markets that they invest in as well as whether they are long or short for managed futures and carry. 

Here's today's screen shot for Stocks and Managed Futures (RSST).

And for Stocks and Futures Yield (RSSY) aka carry. 

There's a lot of differentiation between the two. Additionally, RSST is long metals while RSSY is short the same metals. Managed futures and carry do two different things and the screenshots do a great job of explaining the difference. Managed futures goes long markets in favorable trends and short markets in unfavorable trends. The variation of carry that RSSY uses goes long markets in backwardation and short markets in contango. Those are different things (repeated for emphasis) and so they can be differentiated return streams from each other. I've heard managed futures and carry referred to as being cousins. Similar but different. 

The chart compares RSSY to RSST, the S&P 500 and the AQR Managed Futures Fund. RSST appears to be more volatile than RSSY and there appears to be short stretches where the two trade similarly and other short stretches where they diverge. 

The chart goes back to RSSY's inception and where RSST and RSSY have sawtoothed to small declines, I don't think there's much information yet for backtesting how much differentiation either fund adds to a portfolio but I do think they painting a good picture of how they differentiate from each other.

I don't believe there is a fund that just tracks carry in this manner but the breakout of information for RSSY versus RSST is helpful for learning about carry in case a fund ever does come along. There's plenty to ready about carry and the research is pretty consistent about it being a differentiated return stream so it is surprising there is no fund that just does what the carry half of RSSY does (please comment if you know of a fund that does this).

As for the title of the post, the song is Carry On Wayward Son, the lyrics have the word my, but the title does not. 

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.

Enduring The Languishment

Jeff Malec from RCM Capital Tweeted the following series of charts to help frame what has been going on with managed futures. 

Here's a sampling of what some of the funds have been doing over the same period.

The names don't matter, the group has been grinding around. It may not feel like it but in the same period, the S&P 500 is up almost 5% even though it was pretty flat in October. A few months of grinding around is nothing new if you've been involved with the space for awhile. But what about that five year stretch where moreso than grinding around they were grinding down? For five years. 

If you read posts here regularly, for as much as we talk about managed futures, it seems reasonable to think you might have some interest in managed futures too. Where managed futures are not the thing that goes up the most, most of the time, I think it is helpful to chronicle the periods where managed futures struggles. There was (still is?) all that content about putting a ton into managed futures, the current period is the dark side, the downside of doing that. 

Normalizing the periodic struggles of managed futures makes the struggles easier to endure. Oh yeah, managed futures can struggle for months or years at a time. Any strategy or tools you employ will have tradeoffs and one of them for managed futures is they can languish for quite a while. 

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.

The Permanent Portfolio Influences Everything

Man Institute had a short post titled Not All Alts Are Created Equal. The paper itself wasn't too in depth but they did provide a little bit of a framework for portfolio construction with alts. They suggested 50% in "dynamic traditional assets" which is some combination of "risk managed" stocks and bonds. They didn't provide detail for what they meant by those terms. They would put the other half in a combination of trend following and market neutral and although they didn't say it I took it as 50/50 between the two alt strategies. 

That sort of reminds me of the Permanent Portfolio or at least inspired by the Permanent Portfolio which allocates an equal 25% to equities, long bonds, gold and cash. The big idea is to have uncorrelated return streams or more simply, always having at least one thing going up no matter what is happening.

Not an original thought from me but almost all of these portfolios we look at and play around with here are inspired by the Permanent Portfolio. Obviously, I am pretty down on the diversification benefits of long bonds and Man may have dug up a contributing factor to support my opinion. They note that correlations between equities and long bonds go up when price inflation persists above 2.7%. It has been so long since inflation persisted above 2.7% that I don't know if that stands up but maybe and either way, getting a yield in the fours for 10-20-30 years seems like uncompensated risk or maybe better to say, inadequately compensated risk. 

Each of the following have 25% allocated to AQR Diversified Arbitrage Fund (ADAIX) for market neutral and 25% allocated to American Beacon AHL Managed Futures (AHLPX). You can see the rest of the allocation of the three portfolios and I benchmarked to the Permanent Portfolio Mutual Fund (PRFPX).

The version with VOO is straightforward, market cap weighted equities. SPMO is the Invesco S&P 500 Momentum ETF which has a higher standard deviation which could be thought of having the effect of increasing the equity exposure a little bit but fair if you disagree. NTSX is the WisdomTree US Core Efficient ETF also known as the 90/60 ETF. It leverages up such that a 67% allocation to the fund equals 100% into a 60/40 fund like VBAIX. Putting 50% of Portfolio 3 into NTSX adds capital efficiency (leverage) to the mix, it leverages up 25%.

The CAGRs and standard deviations are all close with a series of small tradeoffs. The version with SPMO compounds 96 basis points higher than the version with VOO but the SPMO version is more volatile by 33 basis points. That's probably worth it but it's not night and day better. The version with NTSX has considerably lower volatility but the CAGR is also quite a bit lower. The numbers for Calmar Ratio and kurtosis are more interesting. Calmar Ratios: Portfolio 1 1.05, Portfolio 2 1.17, Portfolio 3 0.53 and PRPFX is 0.67. For Calmar, higher is better. For kurtosis: Portfolio 1 -0.06, Portfolio 2 -0.60, Portfolio 3 -0.35 and PRPFX is +0.61. Lower is better for kurtosis.

Calmar Ratio and kurtosis are fancy words for similar concepts and can be useful points of understanding. Calmar measures the risk of large losses and kurtosis captures vulnerability to negative, outlier events. The Calmar/kurtosis make sense if you believe in using alternatives. That stats show them providing protection that PRPFX doesn't necessarily do. That fund diversifies with gold and to a lesser extent silver. The other day I mentioned gold as being a less reliable second responder than managed futures and I think we might be seeing that in the metrics. 

Here's a fun study using the VOO version above compared to a different idea using client/personal holding Standpoint Multi-Asset (BLNDX).

Hopefully it goes without saying that I'm never putting anywhere near 85 or 90% in BLNDX. Bitcoin went down a ton in 2022 and then bounced back pretty hard in 2024 and is merely having a very good year in 2024. The effect of including Bitcoin adds 133 basis points to the growth rate but the tradeoff is to increase the volatility by 178 basis points. In terms of risk adjusted returns Bitcoin didn't help but that would change if Bitcoin went on another tear. BLNDX has the attributes of a core holding and catastrophe bonds are very handy at suppressing portfolio volatility. 

The allocation to Bitcoin (asymmetry) is small enough that a 64% decline in 2022 really did not hurt Portfolio 1, it was only down 39 basis points that year. Portfolio 2 is interesting, it is far ahead of VBAIX with much less volatility. It also did better than Portfolio 3 but longer term, I would expect it to lag VBAIX for sure, but with less volatility, and I think it would lag Portfolio 3 but am less certain of that. I think it could be close in most years and take turns being the outperformer but in 2023 when the market was up a lot it trailed VBAIX by 1000 basis points. Maybe I'm wrong about Portfolio 2 lagging though, this year, it is ahead of VBAIX by 200 basis points.

Interestingly the Calmar ratios for portfolios 1 and 2 are very good but kurtosis numbers are not good. Can't please everyone. 

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.

What Is A FIRE Portfolio?

Fund provider Tidal/ETF Masters, more of a white label than an actual provider, had a fun article titled Building A Financial Independence/Retire Early Portfolio With ETFs. The article spells out several alternative strategies to build out a portfolio once you achieve FIRE. 

First, if you've just retired early and plan to draw from an investment portfolio for the next 40 or 50 years, do not load up on a bunch of alternatives that aren't intended to provide something that looks like stock market growth. I'm assuming the situation is someone probably has enough to make it work as opposed to some sort of massive windfall where someone lives a $200,000 lifestyle but has $20 million in the bank. 

In a post over the weekend, we looked at an alt-heavy portfolio to provide high income for nine years. The backtests didn't deplete because market returns were relatively high. Neither did a 10% withdrawal rate deplete an account that just owned the S&P 500, it actually grew in the period we studied. If you expect that your FIRE portfolio will have last 40-50 years then focus on equities, have a decent amount of cash for expected expenses set aside and if you believe in using alts, have small exposures to smooth out the ride a little.

Tidal/ETF Masters talked about risk parity, managed futures, hedge fund replication, inflation protection and derivative income funds. They didn't name names or talk about weightings. Risk parity is really a tough one to invest in at the fund level. This history supporting it is good but that is because bonds had a 40 year bull market. If I am correct about bonds with duration now being a source of unreliable volatility then I'm not sure how a retail-accessible fund would be able to do the job. 

Quick pivot to catastrophe bonds thanks to a short report about the impact of Hurricane Milton. First here's how the three devoted funds in the space have done.

I threw iShares 7-10 Year Treasury ETF (IEF) in for a little context. The report was sent out by EMPIX which is a fund that I am test driving for possible client use. EMPIX and CBYYX have pretty much recovered back to their respective trend lines, maybe a little short of the mark. The drop in mid-September for SHRIX was actually a dividend reduction not a price drop. Hurricane Ian back in 2022 had a bigger impact on SHRIX which as best as I can tell was the only fund in the space back then. SHRIX fell 10% from Ian. 

The threat of the hurricane as it was approaching land caused some markdowns in bond prices. It's not ok to share a lot of detail from the report but one stat to mention is that the benchmark Swiss Re Global Cat Bond Total Return Index only fell 1.34% at its worst. I am less familiar with SHRIX and CBYYX but EMPIX' literature goes out of its way to talk about really trying to tamp down volatility and risk relative to other cat bond portfolios. If you look at longer term stats of the funds on Portfoliovisualizer, that doesn't really appear to be the case but as for the eyeball test during Milton it does appear to have been less volatile thank the others.

All three though have very little volatility and all three have a slightly negative correlation to equities. I mentioned in an earlier post about cat bonds that the thresholds for triggering events, the dollar amount at which the bonds pay out which is bad for bond holders, tend to be very high. The report from EMPIX did not say there were no triggering events in Milton, or Helene for that matter, but the daily updates they sent out when the hurricanes were actually hitting made no mention of triggering events and the snapback in the fund prices imply there were no triggering events. 

Going through this today, I tried to track down the status of the Brookmont Cat Bond ETF which will have symbol ROAR if it lists. I found no news saying there was a problem so maybe it's as simple as not wanting to list the fund during hurricane season. 

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.

"Diversification Without Risk Management"

On Monday afternoon I sat in on a webinar put on by RCM Alternatives with Jon Robinson from Blueprint Investment Partners and Jerry Parker who is a pioneer in trend following with managed futures. The two partner on the Blueprint Chesapeake Multi-Asset Trend ETF (TFPN). Parker also partners with Cambria on the Cambria Chesapeake Pure Trend ETF (MFUT).

The most interesting part of the webinar came at the end with a couple of comments from Robinson. Blueprint worked with Parker from when Parker ran strategies as a hedge fund and has been a believer in the importance of trend and managed futures for a while. When they talked about portfolio allocations he said they want to have enough in managed futures to have an impact on the portfolio. He pegged that number at 25% or 33% but conceded even 5-10% could help. 

One interesting thing about TFPN is that it has a low correlation to other managed futures funds as well as a low correlation to equities. I asked why that was and they believe it's because of how they size positions and also because they use longer/slower signals than most other managed futures programs. TFPN is only 15 months old, if it turns out to be yet another uncorrelated return stream (uncorrelated to not just equities but also other diversifiers) cool but I don't think 15 months is a enough time to draw a conclusion on that. 

We've done this before, but let's see what 25% to managed futures looks like but instead of picking one fund and dumping 25% in, I will split it up with 5% weightings to five different funds. The differences in things like risk weighting, position sizing, length or combination of signals can cause some fairly big dispersion between funds. As we saw the other day, that dispersion between funds didn't prevent them from collectively going up a lot in 2022. 

Portfolio 1 as follows

Portfolio 2 is 50% VOO and 50% iShares 7-10 Year Treasury ETF (IEF). Over the weekend I stumbled into the S&P Balanced Equity & Bond Index-Moderate which is seems like a useful benchmark for blogging purposes and is 50/50 S&P 500 and 7-10 year treasuries. Portfolio 3 is Vanguard Balanced Index Fund (VBAIX) which of course is a proxy for a 60/40 portfolio.

The correlation between the various managed futures funds is interesting. You wouldn't say they are lowly correlated but the correlations aren't that tight so maybe there is some insulation  against things going wrong versus putting 25% into just one managed futures fund. 

We looked at a similar chart the other day. All five funds really struggled from 2015-2020 but there was variation among the five. This five year run is included in the backtest and obviously they weighed on returns, you can see the lag, but the longer term result was competitive.  

Portfolio 1 lagged in most years but stayed close and then moved ahead when managed futures did well in 2021 and 2022. Staying at least sort of close is important. If you think the long term CAGR is compelling, good but the more interesting thing to me is how much lower the standard deviation is as well as the kurtosis which is captured on the metrics tab of Portfoliovisualizer. Portfolio 1 is 0.06, VOO/IEF is 0.61 and and VBAIX is 0.69. Kurtosis captures susceptibility to adverse outlier events and lower is better with this number. Also the Calmar Ratio is dramatically better, 2.0 versus 0.24 and 0.27 and for this one, higher is better. Calmar captures risk of significant losses. 

The other day when I posted a chart similar to the one above where managed futures went down for five years, I said it was generally doing what it was supposed to, maintaining its negative correlation to equities and I asked "would you want 25% in managed futures" during that period. Maybe, that wouldn't have been so bad. 

The tendency toward negative correlation has certainly held up more often than not in my time with managed futures going back to 2007 when RYMFX first started trading as Rydex Managed Futures. This gets us to the title of the post and Robinson's comments around how much to allocate to managed futures. As you dig in and learn more about the systematic nature of managed futures and the other elements of the strategy, you see how important risk management is to the strategy. Yes but I think in terms of the portfolio, I believe managed futures helps to manage the risk of the portfolio. Robinson made a comment almost in passing about the typical stocks and bonds mix being diversification without risk management. If you are well diversified you always have things going up and things going down. If they all go up together, they can all go down together.

You might agree or disagree with that but his point really resonated. 

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.

Depletion Bucket

This post will revisit an idea we have touched on a few time before. The textbook order from which retirees "should" draw from is taxable accounts until depleted, then traditional IRAs until depleted and finally Roth IRAs. Frequently, they never get to the Roth and that can be part of the estate. This has to do with taxes and RMDs but it is very generic. There are countless circumstances where someone should take a different path.

The idea today focuses on the circumstance where the retiree is willing to deplete their taxable account because they want to let their Social Security payout grow or maybe want to wait until they have to withdraw from their IRA or maybe have to wait for their pension to kick in. This sort of circumstance probably wouldn't be too many years unless someone in their mid-50's had their hand forced with their work (layoff or health issue). 

We'll work with what starts as $250,000 in a taxable account that will take $25,000 out annually where the retiree in question is willing to deplete the account. Let's say this person is 61, just retired, prefers to delay starting Social Security until age 70 and will take RMDs at 73 but could take IRA withdrawals earlier if the taxable account depletes. 

I chose Global X S&P 500 Covered Call ETF (XYLD) and Global X NASDAQ 100 Covered Call ETF (QYLD) so that we could get a full ten year backtest. Putting it all in the SPDR T-Bill ETF (BIL) depleted after 9 1/2 years. If it matters, I actually built the withdrawal to be $6250 per calendar quarter. 

Portfolio 1 includes an S&P 500 index fund to provide a little, regular equity market growth. XYLD and QYLD haven't come anywhere close to keeping with with plain vanilla market cap weighted indexes. With dividends reinvested, they have captured half the S&P 500 for the last ten years and without reinvesting they have compounded negatively. 

After ten years you can see how much is still in each portfolio. Even Portfolio 2 which compounded negatively and with a 10% withdrawal rate might still have four more years of life in it. Even VBAIX is in very good shape for a bucket that only needed to last for nine years. 

The portfolios were very successful versus needing to last nine years but of course they benefitted from a strong stock market. It was up nine out of eleven full and partial years, there was a third year where it was barely up which is all pretty close to the rule of thumb about the stock market having an up year 72% of the time. It compounded a little higher than average in that time at 11.32%.

The risk I am getting to in the above paragraph is that stocks don't do as well as they did in the previous ten years. That's tough to model in Portfoliovisualizer, please leave a comment if you know of a way, so to stress test the idea, we can increase the income from $25,000 up to $35,000. When we do that, Portfolio 2 depletes after eight and a half years, VBAIX depletes after nine years and two months and Portfolio 1 depletes at nine and half years. If this depletion strategy had been implemented with putting it all into the S&P, with the $25,000 withdrawals, the balance would have grown to $296,000 and with $35,000 withdrawals would still have $65,000. 

When I had the idea for this post, it didn't occur to me to just put it all in an index fund. I figured that some version of the portfolios we build with the covered call funds would work. Putting it all into an S&P 500 index fund would run into trouble if the period in question included a 2008 when the index cut in half. Also the capital gain potential isn't that much better than one of the depletion portfolios we build because the derivative income funds often include returns of capital which of course are not taxable on the front end but they do lower your cost basis. There are now so many different types of derivative income funds that it would be possible to diversify strategies to take a little less risk. 

It is worth pointing out that all of the dialog about 4% withdrawal rates is built around sustainability over a normal retirement duration which most people peg at around 30 years, at least that is the typical timeline for planning purposes. Talking generically, for someone for whom a depletion bucket makes sense, they are leaving their IRA alone for some number of years to keep growing. In our example, if the depletion bucket lasts for nine years, that could reasonably be enough time for the equity allocation to increase 50-100%. Since 2014, the S&P 500 has almost tripled so 50-100% for the equity portion of a diversified portfolio is not insanely unrealistic. Yes, there is absolutely the possibility that the period that someone needs to do this looks like the 2000's or maybe David Kostin of Goldman Sachs will turn out to be right about 3% annualized growth over the next 10 years. But what retirement plan doesn't need some level of resilience in the face of some sort of adverse market sequence? 

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.