What Happens When You Replace SPY With XLV?

First, an update on the the Millman Healthcare Inflation Guard ETF (MHIG) and the Millman Healthcare Inflation Plus ETF (MHIP). We tried to look at these a couple of times and the most recent time I got information from Copilot that was off by a little bit. 

Here is the "risk" allocation for MHIG

And here it is for MHIP

As I look at the holdings for each fund, they don't quite seem to correspond to the respective "risk" allocations. If they really mean risk allocation then there is probably a risk parity sort of dynamic to the funds, not that they seek equal risk weightings but that they target risk weightings from each segment. Both slides say long term treasuries but it looks like the furthest they go out is five years. I also didn't see any gold, instead they both have Van Eck Gold Miners (GDX), far less than 30%. GDX is much more volatile than GLD so using GDX appears to be a sort of leverage, they'd need to own a lot more GLD to equal the volatility of GDX. Note that volatility and risk are not the same thing but this does create some context for using a smaller weighting to GDX versus putting 30% in GLD. 

The vast majority of the equity is in healthcare stocks with both MHIG and MHIP having small weightings to the S&P 500. For this post, we'll treat the risk allocation as the asset allocation. To backtest we'll use XLV for healthcare equities, GLD for gold and SHY for short term treasuries. Using a five year proxy for "long term" treasuries seems off to me so we'll use TLH which is 10-20 years. 

The results are good. The drawdowns have generally been less than VBAIX or the Permanent Portfolio Fund (PRPFX). Part of the long term success stems from XLV going down much less than the S&P 500 in 2008. There's a low or minimum volatility effect that the backtest benefitted from. Low/min vol is just a factor so sometimes it helps performance and sometimes it doesn't. If we were to shorten the back test to just 15 years then it is almost a dead heat between the MHIP replication and VBAIX. 

The idea of healthcare companies as a proxy for broad based equity exposure is not something we've looked at before. 

The low volatility idea doesn't quite stick in this table but the standard deviation of XLV has been 12.13 versus 9.47 for USMV and 13.92 for SPY.

I didn't include it in the back test but comparing the MHIG replication to AGG, for the entire period MHIP compounded at 7.00% versus 3.03% for AGG and for the last 15 years MHIG compounded at 5.86% versus 2.2% for for AGG. That may not be the best comparison though.

Resolve Asset Management has a paper up about how to diversify within trend following that concludes three distinct management styles is the way to go. Not just three different funds but funds that come at trend differently; different risk weighting or different signal speeds and maybe replication versus full implementation. 

Copilot read the paper and it concluded that the best three funds to capture the intended effect was AQMIX, DBMF and KMLM. I was not wowed by the paper so I asked Copilot "Is the paper compelling or is the conclusion just so-so?" Copilot said it is moderately compelling but not a breakthrough. 

I am all in on having some exposure to managed futures but we've talked regularly about it being a difficult hold.

Over the last year, most funds have ripped higher but the chart makes the point about considering more than one fund. The worst performer in the last year, the pink line, has had plenty of instances where it was one of the best performers. Clients own one dedicated managed futures fund and get more exposure through BLNDX.

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.

More Questions Than Answers

Here's an update from mid-day Monday on the Pershing Square closed end fund and management company situation.

Using the math from Friday's blog post, the combo is worth $4850.40 for someone who put $5000 into the share offering. Gemini found that the sales charge was $1.25/share ($125 on the $5000 number we're working with). Both closed a little higher from when I took the screenshot and the math at the close was $4935.20.

Barron's had more on PSUS and closed end funds in general if you're interested. 

For all the coverage, what's the Seinfeld quote...I'm repulsed but I can't look away, I am not seeing anyone talk about the sales charge and the no free lunch aspect. Bill Ackman was on Bloomberg and he said something about the fund still being all cash and thinking it is odd that anyone paid $50 for a cash portfolio and then immediately sold it at a huge discount. Part of his explanation was that they favored retail investors, retail investors usually don't expect to get their full ask of shares but this time they did and they had to sell to get down to what they really want. 

I am skeptical about all of 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.

Retirement Is Inflationary

The WSJ has a write up noting that not all core bond ETFs are the same. Here's a table that shows the differences.

Or, you could just go an entirely different route.

A few people have talked about the importance of knowing what to avoid which is a concept I believe in. The core funds are more volatile than many investors realize and if rates ever take another meaningful leg higher, then the core funds will get hit hard again. The charts for CGCP and AGG are total return. Anyone who has held CGCP since inception and taking out the dividends is down 11.9% on a price basis and there is no guarantee that they will ever be whole on a price basis. 

Are interest rates going to go up? I don't know but John Authers laid out a theory that is interesting because it is simple and it relies on something that is very hard to argue with. Essentially, the act of saving for retirement is deflationary while the act of retirement spending is inflationary. The country is obviously pivoting older to a much larger percentage of the population being of retirement age. 

If price inflation keeps moving up or stays elevated then that creates visibility for higher interest rates. Maybe it won't play out that way but in terms of assessing risk, the risk here is that this simple theory plays out. 

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.

Money For Nothing And Your Shares For Free

Joachim Klement wrote a provocatively titled article, No, Stocks Are Not A Good Inflation Hedge. The link is to his substack which only provides a short summary to the original article at Reuters which is behind a paywall. 

Ok, is he right? The focal point is when inflation is 3% or higher, "history shows that real returns on U.S. stocks tend to drop quickly once inflation rates top 3%." First, the S&P 500 versus inflation for 55 years which I chose in order to take in the 1970's.

Long term, stocks are well ahead of inflation regardless of the inflation rate. 

Manually counting the year by year layout from testfol.io there were 28 years out of 55 when inflation was 3% or more. In those 28 years, the S&P 500 declined in 7 of them, 25% of the time which is very close to the percentage of years that the stock market is down overall. According to Copilot, in those 55 years, in the years where inflation was 3% or greater the S&P 500 compounded at 9.4% while inflation in those years ran at 6.1%. For just the 1970's, testfol.io shows the S&P 500 compounding at 8.38% versus 8.05 for inflation. Not great but not a negative real return.

Yes there were more instances in the 1970's but I'm not seeing Klement's conclusion. My favorite quote from the show Deadwood was when Hearst said to Bullock, "I am having a conversation you cannot hear." Maybe that's the case here as well with me playing the role of Bullock.  

PSUS is the latest investment vehicle from Bill Ackman. It is a closed end fund that just started trading on Wednesday. It was priced at $50 and to offset the normal decline associated with new closed end funds, the deal also included shares of the management company which has symbol PS for "free." This link might fill in the gaps.

Here's an exchange that Ackman apparently engaged in about the precipitous drop in PSUS' price. 

For a while it was common for new closed end funds to price at $25/share and very quickly fall by the amount of the sales charge which I seem to remember being about $1.50 but regardless of the exact amount, the sales charge built in to the $25 price is not part of the NAV of the fund and the market corrected that quickly. 

The ratio looks like for every 5 shares of PSUS that investors bought, they got one share of PS. So 100 shares on the IPO would have been $5000 and the would have received 20 shares of PS. On Friday, PS was up a ton to $37.99 and PSUS closed at $42.75. Twenty shares of PS plus 100 shares of PSUS adds up to $5034.80 at the close on Friday. I don't know why PS was up $9.99 on Friday but doing the same math 24 hours ago and the two would have added up to $4831.

If this process was correct then it's certainly not catastrophic (let's see what PS does on Monday) but no one got shares of the management company for free. 

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.

You Retire, You Die?

This from Herb Greenberg.

It's not uncommon in white collar professions for people to retire very late or never. The other side of the coin is the reality of people having their hand forced to retire early or at least get bumped out of their jobs sooner than they planned. I recently heard from a buddy I worked with at Schwab in the mid-90's. He's exactly my age and is out of work. I'm not sure if he was still at Schwab until his layoff or had been working elsewhere. If he was at Schwab for 25-30 years then he had the opportunity to accumulate a meaningful amount relative to retirement needs, hopefully a sufficient amount but he made it clear he'd like to be working somewhere. 

His story is just an example of why it is important for people that are maybe 45-60 or whatever age rage you think is relevant to be prepared in case your hand is forced. Everyone has their own Plan A that might involve retiring young or never at all but life happens and it would be better to have something of a Plan B on shelf if you ever need it. 

To the quote, I would replace "you retire, you die" with if you stagnate like leaving your primary career to just sit at home in a recliner watching television you'll probably die sooner. Stagnating, doing nothing is the danger that the doctor is talking about. Having purpose, a place to be with some regular frequency and problems to solve, regardless of whether there is an income involved can overcome "you retire, you die." 

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.

Can I Retire At 55?

Ben Carlson fielded a question from a 45 year old man who hates his job, has $1 million accumulated so far, earns $300,000, spends $12,000/mo and is asking about retiring at 55. He figures he needs $3.5 million at 55 to maintain his lifestyle. 

High level conclusions/observations from Ben;

• The reader is on track but maybe a little variability as to when he'll be able to retire
• There is a question from the reader about return assumptions which Ben notes can be tricky
• Ben makes the obvious but still necessary statement that retiring at 55 means the money needs to last longer
• The reader says he has $30,000 in savings, outside of his 401k and plans to put $50,000/yr into taxable accounts so ten years from now he'd have $530,000 plus whatever growth rate the reader can get
• Ben reminds the reader not to forget about inflation which could mean that in ten years, $12,000/mo might be $16.000/mo

I don't have a lot to disagree on but I think there is some nuance to add. Ben suggests that the reader either "roll the dice" which I take to mean that Ben is not certain things will go as the reader hopes, change careers and/or hire a financial advisor.

First thing I would add is to figure out what he will be spending in ten years. The $12,000 included the mortgage and cars. He doesn't say but the house could be paid off by then. If the house isn't that close to being paid off, paying in an extra $1000/mo would shorten the loan considerably. He could also just keep driving the same cars, the car loans (unless they're leased?) will be paid off by then. Maybe he can cut his nut in half?

If he actually puts away $50,000 into a taxable account every year for ten years, then that pot of money could be very useful as like a bridge to the next financial milestone. Note, we've talked about "depletion strategies" in this exact context but it appears that bridge has become a common term for this. The idea is using the taxable account to live on until it is depleted and by then, he'd probably be able to access 401k/IRA money without penalties (yes there are ways to access 401k/IRA money sooner w/o penalty). I think Ben is more skeptical of the utility of what this piece of money could do than I am.

One point that Ben did not mention is about Social Security. Anyone wanting to retire before 60 should take the time to understand what that will do to their Social Security payout. Social Security is based on the highest 35 earnings years. At 55, looking back to 20 is going to take in some very low earnings years in most cases. Most people will earn more from 50-60 or 55-65 than when they were 20-30. 

It's not that someone should necessarily change their plan of retiring early but they should go through the exercise of seeing what it would do to their payout. When you look at your statement is says something to the effect, this will be your benefit if you continue to earn whatever you just earned. I believe the SS website has a widget where you can tell it to refigure based on retiring earlier. If not, you can plug your earning record into the AI of your choice and get the answer. It would be useful to know if $4000 would drop to $3500 as a made up example to allow for accurate planning. Based on how the reader wrote into Ben, he comes across as very detail oriented and my guess is he would want to know his adjusted SS numbers. 

The last point I would make in response to the reader saying he hates his job two times in the email is that he should just quit now. The bigger point is that if he really stays in a job he hates for ten years, he is essentially going to wish away ten years of his life. It's not that he's a little older and of the mind set that ok, time to start winding this down, he hates his job. 

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.

Can Market Neutral Replace Fixed Income?

Barron's this week had its semiannual "Big Money Poll" that included the following chart.

Avoiding or being underweight duration seems to be catching on. Part of the message from the chart is trying to find different ways, other than bonds, to try to manage or offset equity volatility. To that end, Man group took a look at "equity market neutral as a more effective diversifier." By their work, market neutral does well during periods of higher inflation. They made a fundamental connection to higher costs for capital (higher interest rates). The argument wasn't that compelling but leave a comment if you think otherwise. Maybe market neutral does better is less about market neutral and more about bond prices dropping due to higher yields typically associated with higher price inflation. 

While I did not take Man to say 60% equities/40% market neutral, lets see what that looks like. Similar to managed futures, if you want to go heavy into market neutral, diversify your diversifiers, there can be idiosyncratic risks with these strategies.

Vanguard Market Neutral (VMNIX) was anything but in the period charted.

Here's part of the story from Copilot;

Here are four funds that have less violent histories. 

The Merger Fund is in my ownership universe. One fund that I excluded was AQR Market Neutral (QMNIX). It too looked very unneutral at the same time as VMNIX.

Taking all four and weighting them each at 10% to create a 60/40 looks like the following;

Portfolio 2 looks just like VBAIX until bonds with duration start to have problems in late 2021 then it pulls away, going down less in 2022 and has outperformed VBAIX by varying degrees every year since. 

Hold on though. The result for the Blackrock Global Equity Market Neutral Fund (BDMIX), seems to have much better result than the others. That sort of outlier, even if it's good, should prompt a closer look. Why has it done so much better? Is it taking risk for which there has been no consequence yet?

Copilot has thoughts.

It really spat out a lot of information, I think this screen grab summarizes most of it. Maybe for a 10% portfolio weight, it's worth the risk or maybe the weighting to that one can be reduced some but part of the process for considering an alternative strategy is to take some time to understand the why behind the performance not just look at the performance. Assuming Copilot has it right, getting to the bottom of a fund like this probably wasn't possible before AI. Copilot does similar things looking across various managed futures funds to quickly isolate risk weightings and signal speed. 

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.