What's Wrong With Managed Futures?

A very long running theme to my writing going back almost to the beginning has been to avoid allocating too much to specific diversifiers. We've talked about this in relation to MLPs. gold and REITs going back 18 or 19 years and more recently we've talked about what a bad idea a 20 or 25% weighting to managed futures is. The behavior carried forward from REITs and the others to managed futures maybe a year or year and a half ago with a lot of content pointing to huge allocations to managed futures.

I wrote a similar post along these lines recently. There a couple more recent points we can add in to this discussion. First was Corey Hoffstein cowrote a paper that he gave a TLDR version on Twitter that appeared to be in support of managed futures replication which is typically how ETFs put on the strategy. The mutual fund wrapper is more amenable to full implementation. The takeaway for me was the potential performance dispersion across different funds. If you have interest in the space and maybe monitor a few funds you'll notice day to day differences of course and those differences can be pretty big over longer periods.

The differences are a little more nuanced than being long or short some currency or commodity. The differences often relate to different forms of risk weighting, the extent to which a strategy might use any faster signals for positioning and how the fund handles it when a 10 month signal conflicts with a 30 day signal as some examples. Here are four different managed futures mutual funds going back five years.

There are some distortions from how Yahoo handles year end distributions which were big at the end of 2022. The dispersion among the four is pretty wide but they all worked when investors needed them to work in 2022. Now check out the five year period below.

Would you have wanted 25% of your account in managed futures in that run? Research that concludes 25% into managed futures is overly academic, IMO, for real world implementation. I'm saying this as someone that has been a true believe for more than 15 years. 

I don't think a five year run like the one above is going to be repeated anytime soon but as a group, they could easily languish for a long time. A "permanent" low-mid single digit weighting would merely be a drag on returns but a 20-25% weighting could be a real problem. 

This bar chart comes from Bob Elliott and Unlimited Funds.

That's a lot of alternative strategies that did well in the third quarter with one that did poorly. I always say that no strategy can always be best and I should add that every strategy will take a turn being worst. By Bob's work, managed futures were down a little over 2% in the third quarter while the S&P 500 was up 4%. Repeating what I said frequently back when managed futures was struggling, it was doing what it was supposed to. Managed futures tends to have a negative correlation to equities so if equities go up, it should not be a surprise if managed futures go down. Managed futures can of course go up with equities but I would not expect it do so. 

The next time there is some sort of stock market calamity, not a crash but more like a bear market sort of event, my guess is that futures will do well and again bring out the put 25% into managed futures crowd. Assuming you do not want to be in the business of guessing when managed futures will have a great run, think of the strategy as a way to diversify volatility in the thing that will provide the most growth which of course is equities. In that light, a small allocation will make much more sense. 

An exception to quite a few of the "rules" we talk about is the Standpoint Multi-Asset Fund (BLNDX) which is a client at personal holding. It blends equities and managed futures in search of an all-weather result and for my money it delivers that result very consistently. Yes, ReturnStacked Stocks and Managed Futures (RSST) does something similar but they have different goals, they set different expectations and for my money, literally, it does a much better job of meeting the expectation they set than RSST. Even still, the exposure to BLNDX is nowhere close to 20-25%. 

I think there is a vanity aspect to putting so much into managed futures. It is a sophisticated strategy that is intellectually appealing and plays to your ego. It's ok to feel that emotion but the point is to not succumb to that emotion. Diversify your diversifiers because Q3, 2024 will not be the last time managed futures lags the other alternatives. 

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.

Mystery ETF Revealed

Some interesting, quick ETF stuff today. 

Below is a chart of the Tradr 2x Long SPY Weekly ETF (SPYB) compared to the S&P 500 and the ProShares Ultra S&P 500 ETF (SSO). Where market cap weighted 2x S&P 500 funds are concerned, they tend to be close more often than not. One month is not enough time to draw a conclusion about SPYB but it better then coming out of the blocks and failing right away. I check all three of the Tradr 2x Long SPY ETFs every day and not surprisingly, the quarterly version which has symbol SPYQ, usually has the most volume.

Here's a filing where I love the concept but think it would be very difficult to have success actually using. 

The idea is that the fund would go long the first symbol, like NVDA and short the second one like INTC. These aren't market neutral pairs trades like maybe going long Pepsi and short Coke a Cola or an example from many years ago, long Intel, short AMD. They appear to be paired to go all out for alpha. I modeled a few of the ones listed. 

The result is fantastic from a learning perspective. Long Amazon, short Macy's failed. Long Google, short New York times had negative compounding. I'm sure Battleshares, love the name though, are intended as shorter term trading vehicles but you really have to get several different and potentially unrelated things correct in order to make money with these.

Let's take a look at whether complexity is compensated or uncompensated. We've mentioned the PIMCO StocksPLUS Long Duration (PSLDX) which is 100/100 stocks and long bonds. There are other funds in that suite including the PIMCO StocksPLUS Absolute Return (PSPNX). PSPNX leverages up 100% equities and 100% absolute return. For a little context, putting an entire portfolio into PSPNX would have compounded since inception at 13.89% with a standard deviation of 19.29% versus 14.67% and 17.51% for the S&P 500. The idea is not that anyone put it all into PSPNX but those numbers give an idea of how it behaves. The potential use would be how a smaller weight incorporates in to a diversified portfolio. Is the complexity of combining equities and absolute return compensated or uncompensated?

Both Portfolios 1 and 2 do better than Vanguard Balanced Index (VBAIX) which is a proxy for a 60/40 portfolio. Between 1 and 2 it's sort of a push. With Portfolio 1, the gain in return over 2 is greater than the increased volatility. The advantage of Portfolio 2 is that the 10% in T-bills provides insulation against sequence of return risk. Whether the complexity of either portfolio provides enough compensation is up to the end user but the portfolios are fairly described as simplicity hedged with a little complexity, whether you're talking about ADAIX or PSPNX.

The STKD Bitcoin and Gold ETF (BTGD) that we wrote about yesterday actually started trading today. It didn't have a great day. 

Earlier this week, I wrote about a mystery ETF and tested it out as part of a diversified portfolio. The mystery fund is the McElhaney Sheffield Risk Managed ETF (MSMR). It owns equites via two different strategies, trend and sector rotation. As a stand alone, it hasn't kept up with the S&P 500 but as a sort of hybrid with some low volatility attributes and some fixed income attributes it appears to have added value when used in a correct proportion. 

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.

Crapping All Over A New Fund

All right, let's get into this. Today the STKD Bitcoin & Gold ETF (BTGD) appears to have started trading. The fund's website says October 15 is the inception date but Yahoo Finance doesn't have it yet. It's from Quantify Funds but Newfound Research, ReSolve Asset Management and Return Stacked ETFs are all involved too. BTDG leverages up to own 100% Bitcoin and 100% gold in a similar fashion as the ReturnStacked suite of ETFs. 

I don't think this is going to do what people hope it will do. First, this blend was tried a few years ago albeit with a very different strategy. The Ranger Funds RG Agrium+ Fund was actively managed and combined Bitcoin and gold in a manner that typically favored gold. Going from memory it was something like 75% gold/25% Bitcoin most of the time but that was not static. 

Gold is the green line and GLDPX is the blue like. I tried to include Bitcoin on the chart but it made both GLD and GLDPX look like horizontal lines. Bitcoin was mostly up a ton. The chart shows a mix of GLDPX sometimes looking like GLD and sometimes being negative correlated. In the 3rd quarter of 2021, Bitcoin doubled and you can see GLDPX didn't capture any of it. It did capture the decline in Bitcoin that ran from November 2021 to Feb 2022. The fund did not last long.

Here's a backtest of what BTGD does compared to just gold and just Bitcoin.

Whatever reason someone might want gold, the 100/100 blend isn't capturing it, it looks just about identical to Bitcoin. I could have gone back further with this test but Bitcoin was up so much that it made the chart pretty noisy looking but you can look for yourself, the 100/100 always looks like Bitcoin. 

I think I know why it doesn't work. It's a mismatch of volatility profiles such that Bitcoin crowds out gold. Above, GLD shows a standard deviation of 13 versus 65 for Bitcoin. Below, I rejiggered it to match the volatility profiles with 300% in gold and 50% in Bitcoin and the result shows some differentiation between the 100/100 which we've already established looks just like Bitcoin.

I said it shows some differentiation. Does it show enough differentiation? The gold smoothed out the ride when Bitcoin was more volatile in 2021 and lately the 300/50 blend has been pulling ahead. We've looked at very small slices to Bitcoin being able to add a lot of basis points of return to a portfolio. I've been clear that unless you're a true believer, the story is about asymmetry. A 1-2% allocation that goes to the moon will favorably impact a portfolio and if it goes to zero, a diversified portfolio could make that loss up very quickly. Gold has the tendency to go up when stocks go down. That's not infallible, it's merely a tendency. 

Assuming BTGD really did start trading on 10/15, I think it will just be a proxy for Bitcoin but with the "uncompensated complexity" that something bad and unforeseeable happens with the leverage. 

Part of what the various 100/100 funds are trying to offer is a way to add in exposure to some sort of asset class or strategy without having to reduce exposure to the building blocks of equities and bonds. They place a high priority on doing this to avoid tracking error. First, tracking is probably not as important to the typical advisor or do-it-yourselfer as they think. Arguably, you want some tracking error. When I talk about smoothing out the ride, that means tracking error. Too much can be an issue at times but I believe you do want some tracking error. 

Ok though, let's say you place the same priority on tracking error as the ReturnStacked guys. Look at the funds. Are they actually avoiding tracking error? You might know what I think but so what, what do you think, are they avoiding tracking error? Below is their first fund. It owns AGG-like bond exposure combined with managed futures so comparing it to AGG for tracking error makes sense. 

RSBT and AGG are slightly, negatively correlated. Leave a comment if you have a different take but this is not solving a problem, it might be causing a problem. As we talked about the other day and I used the phrase above, this seems like uncompensated complexity. 

If you think you have to do this sort of leverage, portable alpha type of thing, there would be less complexity using a leveraged S&P 500 ETF. There's still plenty of risk with those but there is less complexity. They lever up one asset, not blending two together with leverage. 

I continue to monitor the Tradr leveraged SPY ETFs. Above is SPYQ which just started two weeks ago and resets quarterly. For backtesting on Portfoliovisualizer, I use ProShares Ultra S&P 500 (SSO) but I think SPYQ will prove out to be a better mousetrap. All the SPYQ chart tells us is that it is making a good first impression that is sort of consistent with SSO long term. If you play around with SSO on a chart, you'll see it is reasonably close most of the time. Not all the time, most of the time. 

In past posts we've looked at combining a plain vanilla index ETF with a small slice to a leveraged fund to then make room for an alternative strategy. Putting 50% into a plain vanilla ETF and 5% into SSO or SPYQ if that one proves out, equals 60% to equities with 5% for an alternative. 

Out of curiosity, I looked for a 2x momentum ETF. The plain vanilla momentum funds do some interesting things, maybe a 2x would too. Maybe, but no. For whatever reason, the one 2x momentum ETN, it's not even an ETF, doesn't appear to "work."

Oops. Leveraged funds are tricky. The risk of 5% into SSO or SPYQ is not huge but it might very well drift into uncompensated complexity. 

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.

Mystery Fund Makes Good First Impression

I stumbled into yet another new (to me) ETF to kind of experiment with. For now, I'm going to leave the name out of it and just call it the Mystery ETF and to make the post easier for everyone, lets give it symbol $$F. I'll share the name on a subsequent post. This should be a good way to work through the expectation that a fund is setting, whether it generally meets that expectation and how it might fit into a simple portfolio. The fund started trading in late 2021 and is small, with $69 million in AUM. It would be fair to call it an alternative strategy but it uses standard assets. 

A couple of snippets from the fact sheet are that $$F "is focused on delivering growth, but with an emphasis on risk management through stop loss techniques and use of defensive allocations" and "attempts to limit the downside during bear markets then capture upside when the market rebounds." It will have equity exposure at times and can get defensive so it should be less volatile than the S&P 500.

$$F is also much less volatile than USMV but only trails by 99 basis points for CAGR. It hasn't looked anything like AGG but I'm not sure the three year window we have to study allows for drawing an accurate conclusion on that. The 2022 results;

So, is $$F generally meeting its expectation? The return was remarkably smooth until about April of 2023 when I imagine it flipped out of defensive mode and started to look a little more like the equity market. In 2023, $$F was about 700 basis points behind VOO but 800 basis points ahead of USMV and this year it is 445 basis points behind VOO and 93 basis points behind USMV.

If I have the messaging correct from $$F, it is telling you it will be less volatile so the results thus far make sense to me. The chart above is instructive, you can see how it pivoted from some sort of defense to some sort of fully invested posture. I can't tell if $$F could be a substitute for the Vanguard Balanced Index Fund (VBAIX) which is a proxy for a 60/40 portfolio. With the short period available to study, the distortion of the bond component in 2022 weighs too heavily to draw a firm conclusion but I modeled it out below with a couple of other comparisons. 

This is also skewed because AQR Managed Futures was up 35% in 2022 which may not be repeatable the next time stocks go down a lot. The year by year might be more useful.

Blending $$F with momentum delivers a valid result that is in the mix with the benchmark VBAIX but with less volatility. The point of this post is not to run out and buy $$F but to try to understand what a fund is trying to do and then assessing whether it is doing what the provider says it will do. Where $$F has a process that determines its allocation, I'm not sure that a little less than three years is enough time to know it can repeat what it has done so far but it makes a good impression and the result thus far are better than not really coming close to what it said it would do. 

I'll share the name later this week. 

And another new ETF to look at. Are there quick little comments either said you or that you read or short quotes that although not necessarily sage advice, stay with you for whatever reason? One that stays with me was someone on Twitter commenting ages ago to "just put it all in a quality/momentum fund and leave it alone." The only fund I knew of that combined those two was the Alpha Architect Quantitative Momentum ETF (QMOM) which despite the name does blend quality with momentum. 

I would say QMOM has been a rough hold, lagging the S&P 500 by 192 basis points annualized which is ok but QMOM has been 50% more volatile than the S&P 500. In nine full and partial years, it has lagged the S&P 500 in six of those years. It was down much less in 2022 but interestingly, it was down in 2021 too. The CAGR might be overstated in terms of expectations due to going up 62% in 2020 versus 18% for the S&P 500. I would not assume that outperforming by 44% in one year could ever be repeated and that result might be part of the story for why QMOM fell in 2021. 

Despite the challenges QMOM has had, the person putting so much faith into quality and momentum still could be onto something. At least I play around with this idea every so often. This gets us to the SMI 3Fourteen Full Cycle Trend ETF (FCTE). FCTE is a concentrated portfolio of 20 stocks that "uses a proprietary Quality screen to narrow the potential universe, then applies a variety of proprietary Trend and Momentum screens to select the ETF's portfolio." The fund just started trading in July and already has $472 million in assets which is astounding for a fund that ETF-Twitter doesn't talk about and for a fund that I've never received a solicitant email for. The fund might be a BYOA situation or bring your own assets as Eric Balchunas says but either way, it's impressive and the fund has done well so far. 

It came out of the blocks strong and then pulled away again in the first half of September. JOET is the Virtus Terranova US Quality Momentum ETF that somehow involves CNBC personality Joe Terranova. As a side note, I bailed on CNBC in favor of Bloomberg so long ago, I have no idea if Terranova is still on CNBC. Beyond assuming at least slight differences in determining quality and momentum between FCTE and JOET, JOET does not appear to be a concentrated portfolio. Three months is way too soon to draw any conclusion about FCTE versus JOET or FCTE versus anything but I am intrigued by the quality/momentum blend.

Modeling the idea out, QMOM and JOET don't do relatively well so I'm leaving those out so there is less noise and a longer period to look at.

Everything is plainly labeled. 75% Momentum/25% Quality is interesting. For the same standard deviation as the S&P 500, the backtest got 191 more basis points of compounded growth. And you can see that both momentum/quality blends had some crisis alpha in 2022.  

The year by year doesn't show a ton of differentiation but there was some. The reason to mention that point is the less something looks like the S&P 500 the harder it can be to hold, behaviorally. It's funny to say but you want some differentiation, not too much. Also, there is nothing in the back test that stands out as being unrepeatable like the one year QMOM was up 62%. 

 FCTE could turn out to be a better mousetrap, I have no idea but I think it is in the right part of the factor world and it makes a good enough impression to want to follow it. 

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.

When Your Auntie Goes Off The Rails

I stumbled into a new option income fund with the Peerless Option Income Wheel ETF (WEEL). This graphic explains the strategy.

It started trading this past spring and does not stand out as being particularly bad or good. 

As of last Friday, it owned just just two ETFs, an oil services fund and a semiconductor ETF. For now, it is mostly short put options on ETFs. I am writing this post late in the day on 10/11 and most of the puts show expiring today. I sampled a few of them that all appeared to be about 5% out of the money. 

The chart compares WEEL to ProShares S&P 500 High Income ETF (ISPY) which I own and sells daily call options, XYLD is the Global X S&P 500 Covered Call ETF which sells monthly call options, WDTE which sells daily put options and used to have symbol JEPY, not to be confused with JEPI from JP Morgan and the last item on the chart is just the S&P 500. WEEL at first glance is more of a put selling strategy which is why I threw in WDTE. The decline in WDTE isn't just about the dividend. Portfoliovisualizer has that fund down 10.05% on a total return basis through Sept 30th. 

WEEL should not be expected to be a proxy for the equity market. It has had a much lower return thus far and a much lower standard deviation. That it won't keep up with plain vanilla equities is not a bad thing if holder realizes this ahead of time. It has paid one $0.60 dividend so far and while the dividend could be lumpy going forward, it looks like it will pay quarterly and extrapolating the $0.60 payout the fund could yield 11-12%. The attributes of lower volatility and much higher yield have a spot in a diversified portfolio but again the expectation is that this is not a proxy for the equity market.

The risk of selling volatility this way is that the market gets hit either with a fast decline like the 2020 Pandemic Crash or a slower large decline like in 2022 causing the short puts to get assigned. As of Friday, WEEL was short puts on the Van Eck Semiconductor ETF (SMH). SMH closed at $256, the puts are struck at $235. SMH has 20% allocated to Nvidia (NVDA). If something hideous happened to NVDA that took down the whole group then the fund might have to pay $235 for an ETF trading at $210 as an example. 

If WEEL sells puts on ETFs and not individual stocks as it appears then I don't think there could could be a catastrophic outcome like down 70% in a down 25% world but in trying to frame this out, down 30 or 35% in a down 25% world seems within a normal distribution of outcomes. I saw plenty of down 70% in a down 25% world outcomes during the popping of the internet bubble when individual internet stocks were cutting in half or worse, very quickly. That's not a likely worse case scenario for the types of ETFs WEEL owns but I suppose it's not impossible. To be clear, WEEL doesn't use leveraged funds, YieldMax funds or other funds like that which can blow up.

Pivoting, the Wall Street Journal had a very short interview with Alicia Munnell as she retires from the Boston College Center for Retirement Research at age 82. Munnell along with Teresa Ghilarducci are like the aunties of retirement which I am saying in a positive way. They don't really talk much about bottom up retirement planning, more like big picture, how to fix the system, top down retirement issues. 

There was an odd thread from her. "Like many people, she lacks the time and interest to manage money, she says." Her son works in the industry and helps her every so often. "'If I had to figure out what to invest in, I’d have no clue,' said Munnell. 'People have busy lives. Retirement planning should not be something they have to put a lot of effort into.'” I'm sorry but what?

I have trouble believing she is that checked out. She would have no clue? Really, none? Put it in a balanced fund and leave a year or two's expenses in cash. That would not be optimal in my opinion, but certainly valid. People shouldn't put effort into retirement planning? What does that even mean? How does someone from the BC Center for Retirement Research, someone from any center for retirement research believe something like that? 

Even people who seek out help from an advisor need to engage and make some decisions. In general, the more effort people put in to something the more they will get out of it. What sort of retirement output do you think you'll get not putting much effort into your retirement? If the article correctly captures what she is saying, it is absurd. As Joe Moglia said, no one will care more about your retirement more than you. 

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.

Uncompensated Complexity

Eric Crittenden sat for the Algorithmic Advantage podcast, it was about an hour and twenty minutes and covered a lot of ground. Crittenden manages the Standpoint Multi-Asset Fund (BLNDX/REMIX) which I've owned personally and for clients pretty much since the fund listed. 

There were some great points made to share and explore. The first point is that I think he validated a point I've been making for many years about managed futures and the importance of T-bill yields to the funds in the space. Most the of the managed futures funds are in treasury bills which collateralize the futures program. A question I raised more than ten years with a hedge fund data wonk was isn't yield on the T-bills a huge contributor? Yielding a half of a percent versus 4-5% would seem to matter a lot. I've been routinely told no when I've asked several people but I think Eric was saying it does matter, it is at least a useful contributor to the strategy.

The story behind the founding of the strategy underlying BLNDX and then the fund itself has a very long runway that you can check out for yourself on the podcast but the asset mix that led to BLNDX is what he thinks is the optimal portfolio based on many years of research. He believes it provides the best chance for an "acceptable" real return in all market conditions. That gives some good color on his use of the term "all-weather" to describe the strategy.

Eric also acknowledged how difficult it is to hold managed futures from week to week and month to month. This makes sense. It is a diversifier with the tendency of being negatively correlated to equities. Equities being the thing that goes up the most, most of the time, a strategy that tends to be negatively correlated to the thing going up most of the time will of course be difficult to hold. We appear to be in a stretch right now where that is true. Being difficult to hold probably applies to most alternative strategies which is a crucial building block for understanding what diversification really is. As Jason Buck has said, if you're really diversified then you have at least one holding that makes you want to puke. 

He articulated the asset mix of his optimal portfolio in a way that I hadn't heard him discuss before. BLNDX is 50% equities and then a range of managed futures of 50 to as much as 100%. But then he talked about T-bills being part of the mix too which of course they are and always have been. He didn't quantify the equities/managed futures/T-bill mix from his research so I took a guess and the results are interesting. 

The 25/25/50 blend did not keep up with BLNDX but it did offer a real return with very little volatility. Going back ten years, 25/25/50 compounded at 5.69% with a standard deviation of 5.73% versus 8.41% growth and a standard deviation of 10.27% for VBAIX. The ten year numbers for 50% VOO/50% AQMIX were 8.85% and 7.76% respectively. 

The most interesting part of the podcast was when he talked about getting rid of uncompensated complexity. This connects with two things we talk about here. First is my description of building a portfolio comprised of simplicity, hedged with a little complexity as well as assessing whether a strategy delivers on the expectation being set. The now closed Simplify Tail Risk ETF (CYA) blew up very quickly. I believe it was done in by the VIX portion of its strategy but either way I would say it never lived up to the expectation it set. Simplify has a fund that owns the S&P 500 with a put option overlay that somehow went down more than the S&P 500 in 2022. Same story, didn't meet expectations, these are examples of uncompensated complexity.

Above are two more funds that I don't believe meet the expectation they are setting, both compared to VBAIX. FIG, the blue line, "is a modern take on the balanced portfolio, built to help navigate today’s toughest asset allocation challenges." The Risk Parity ETF (RPAR), the pink line, "Seeks to generate positive returns during periods of economic growth, preserve capital during periods of economic contraction, and preserve real rates of return during periods of heightened inflation." Ok, how's that going? How soon before these should start to work? I don't know about FIG but I thin RPAR might have been an implementation of a successful backtest that did not look forward to see that bonds with duration were going to be a big problem. Typically, risk parity which is what RPAR is, loads up on bonds. 

Checking in on catastrophe bonds, I thought the following two screenshots would useful learning tools. First is sort of an asset allocation picture from the Pioneer Cat Bond Fund (CBYYX).

I'm a little surprised how much was exposed to Florida hurricanes but that is obviously where much of the threat lies. The next screenshot lists some of the positions in the Ambassador Fund (EMPIX) which I am test driving in one of my accounts for possible use for clients.

Two things to note here. Cat bonds are not really bonds in the manner most people think. They are T-bills with what amounts to a note or a rider bundled in to add up to a higher yield. The other thing is I highlighted the different reinsurance companies transferring the risk via the bonds. On other pages of the holdings there are duplicates of reinsurers but there is work done by the fund managers to try to diversify issuers. The funds are designed to spread the risk very broadly but obviously, anything can happen at anytime. The yields are high, there is a risk tradeoff to consider which is an argument to keep any sort of weighting small. 

Finally, if you're interested in the 351 Exchange I mentioned the other day where you swap your portfolio for shares in an ETF to capture tax efficiency, here's a good primer from Cambria who is looking to bring this to market. I got a couple of the conclusions wrong about tax basis and that there will be requirement to "buy in" with a diversified portfolio as oppose to just a position in low basis stock. It's not looking like I will have any clients for whom this makes sense but will keep trying to take in more information.

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.

Spitznagel Is Not A Fan Of 60/40

Comments from an interview of Mark Spitznagel made the rounds. Here's a version from Bloomberg, Yahoo and Unusual Whales. The Bloomberg version has a short video, it was not the entire interview. Spitznagel runs the Universa Fund which is a tail risk fund. Regardless of whether he's talking his book or genuinely bearish all the time, he usually does a good job framing out the prevailing bear case. There is always a prevailing bear case. This time though, he wasn't that persuasive. It might have just been how the interview went, but he talked about complacency and a little about 2022.  

More interesting were comments about diversification being "deworsification," it's a "big lie" that has left people worse off. Ok! We've got something to chew on there. To the extent he meant diversifying with bonds, I can't get to it being a lie but clearly I've felt they no longer are anywhere near as effective as diversifiers. This a theme we've been working on here for many years. Bonds with duration went from insanely risky because of how low the yields were to now being unreliably volatile. Income sectors that avoid interest rate risk still work as far as I can tell. 

Spitznagel specifically says that diversification isn't the holy grail it's made out to be. I'm not sure, but that might be a shot at Ray Dalio's idea about having 15-20 uncorrelated return streams as being the holy grail of investing. 

I won't entirely rehash the last three years worth of posts to take the other side of his opinion. We've been on the case with negatively correlated return streams since before the Financial Crisis with inverse funds and RYMFX. Of course my understanding as well as the products available have evolved considerably. There is a long list of funds with strategies that offer negatively correlated return streams and uncorrelated return streams to diversify equity volatility. It turns out that a lot of those diversifiers are uncorrelated with each other. We've seen the general effect work in various types of adverse market regimes. 

Finding them is easy. They're out there and we've looked at them plenty. Figuring out the sizing is a nuanced process. I've said many times before, you do not want a portfolio of diversifiers hedged with a little bit of equity exposure. Equities are the thing that go up the most, most of the time and unless you're in some variation of game over you want equities to be your largest holding. Hanging on to diversifiers can be challenging too. It is very human to give up on something that seems to not be doing much but there is no way to know when they will be needed to carry the portfolio.

Checking in on the catastrophe bond mutual funds at Wednesday's prices.

Yesterday, I mentioned some quirkiness with mutual fund reporting. EMPIX was up on Tuesday and as you can see up on Wednesday. EMPIX has generally held up better so far but I don't draw any sort of conclusion from that. It doesn't track for me that the bonds are so efficient that we have a good picture of what is really going on days before we have a real handle on the damage. It might be weeks before the market knows. I'm not sure which is why I am tracking this and why I am test driving EMPIX in one of my accounts for possible use in client accounts. 

After I wrote the above paragraph I got some more information. One via email confirming what I said about it taking a while to sort out the true extent of the costs. It said weeks or even months. Both the email and this Bloomberg article reports estimates of the costs coming down quite a bit. In one blog post, I said that the dollar threshold for triggering events is usually very high. It is still not known whether there were any triggering events from Milton. It's a good bet there were but that hasn't been reported yet. For whatever reason, Bloomberg has had content about cat bonds every day through this which has helped tremendously.

Time got away from working on this post and so we now have Thursday's prices for the cat bond mutual funds, perhaps reflecting the sentiment of the Bloomberg article about the damage being less than the worst case scenario, dollar-wise.

On a related note, earlier this week I saw that the Brookmont Catastrophic Bond ETF (ROAR) did not issue when expected, It was supposed to hit the market during the summer but hasn't done so. I am not sure if it is merely delayed or not going to happen. It would have been interesting to see ROAR react during the trading days this week. It might have been instructive but as I said before, I don't think cat bonds are easily ETF-able.

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