Beta & Carry

Goldman Sachs posted a research paper that makes for a good follow up to our recent conversation about a potential lost decade for domestic equities. 

There are a couple of high level points from the paper to mention. First is that higher inflation is bad for 60/40. They said that higher interest rates which are associated with higher inflation make equities less attractive. That's a point about tradeoffs and is a widely accepted truism of markets. And if yields keep going up, that of course is bad for bonds with duration. 

I would push back partially on higher rates being bad for stocks though. Rates moving higher, everything else being equal, yes would be bad for stocks but if we get into a period where rates stay generally higher than we've seen, I think equities would adjust to that and eventually work higher. In this context, I don't mean rates going into the mid-teens like 45 years ago, just higher than they've been, 6-7% maybe instead of 4-5%. 

The basic conclusion is to underweight equities without bailing on innovation, specifically they mean AI. They say there is a poor backdrop for equities now but completely avoiding innovation is too risky. 

Most of their scenarios point to below average growth for equities except Goldilocks inflation plus an AI boom. The diamonds are the suggest equity weightings in the various scenarios they identified.

The follow up is to build on the yieldy portfolio we looked at the other day which did ignore innovation. We'll try to build some innovation back in with GlobalX Artificial & Technology ETF (AIQ). Goldman talked about foreign equity exposure too so I also added iShares International Quality ETF (IQLT), a new one for blogging purposes, as follows.

The version from the other day just put 25% into SCHD. Goldman included risk parity in their study but their results don't favor it so I included a version weighted for risk parity from Finominal too. 

 The inflation adjusted numbers were;

Looking backward, the ideas we're exploring have nowhere near 60% in domestic equities so a long run where domestic equities did very well, portfolios that were much lower in domestic equities aren't going to keep up but the results can still be plenty valid. Eight years is a decently long time to see how these different types of holdings mix in with each other. If there is a lost decade coming for US equities, having more yield and some all-weatherish attributes makes sense to me. The yield for the portfolio is just over 6% which is high but not frighteningly so, the drawdowns were reliably shallower and Portfolio 1 was up very slightly in 2022. 

A huge challenge to this entire concept is being able to discern between regime change versus a just a bad year. The key is realizing there's no reliable way to do this. I was able to sidestep quite a bit of the financial crisis (my posts at Seeking Alpha from back then corroborate this) by simply recognizing that bad things happen when sectors grow to 30% of the S&P 500. I was able to sidestep the meltdown in bonds with duration by asking the very simple question of whether yield adequately compensated the risk. 

The things I think are problematic for domestic equities now include erratic bond behavior, clear and obvious excesses in the capital markets related to tech, price inflation and there are others. There are always risk factors so now is no different in that context but I think the threat level has elevated. If somehow we do have a stretch where domestic equities do poorly, yes I think you need some foreign equity and I already do. I think the portfolio would need some yieldiness and it already has some. I think the portfolio would need some absolute return and it already does and I think it would need some crash protection which it already has.

That is all predicated on not believing I can predict anything. Believing or realizing risks have elevated is not the same thing as making a prediction. If something bad happens, the question then will be did I have enough of those things and here, right now, there is no way to know. The process in this post is unrealistic for me because I can't see reducing clients' equity exposure from 50-60% down to 20-25%. If things present themselves in an obvious way (it could happen), then reducing some exposure in favor of a little more yieldiness and a little more defense is in the realm of being practical. 

I'm trying to come up with a clever tag line for this idea; Yieldy Beta? Beta & Carry...I don't know, we'll come up with something. 

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. 

EFT Go Boom

The Opportunistic Trader ETF (WZRD) is down 97% year to date at Friday's close.

This is not a fund we've ever looked at here but Gemini thinks that the fund got hurt buying ODTE options and that those trades went wrong. ODTE stands for zero days to expiration. Assuming it's as simple as Gemini reported, going long volatility in that manner is a tough way to make a living.

VistaShares closed the Bitbonds 5 Year Enhanced Weekly Distribution ETF (BTYB). The fund allocated 80% to five year treasury notes and 20% to selling Bitcoin calls in an attempt to double the yield of the five year. When I looked, it seemed like it was doing what it was supposed to. The concept seemed solid to me as a sort of barbelling to magnify the yield. It did not trade like a hot potato so I am surprised it closed so quickly.

Something that I am getting a kick out of, there's finally going to be an ETF comprised of publicly traded exchanges, the Van Eck Global Exchanges ETF (TIKR). I first brought this up many years ago on the first iteration of the blog. The following is a list of the probable constituents. 

I've owned a publicly traded exchange for clients almost since they first started to go public quite a few years ago. From the bottom up, I believe they are cash flow machines and from the top down, it's an easy way to add non-bank financial exposure. 

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. 

Time To Get Yieldy?

The other day I mentioned starting to think about how to gameplan having a lost decade for stocks. That's not an attempt to predict anything, more like if it happens...then what? 

In the last lost decade for stocks, bonds did pretty well which helped the traditional 60/40 do relatively well considering equities floundered.

If there is another lost decade, it is plausible that factors like quality, value and dividends would do better than market cap weighted or growthier factors and sectors. Looking at the first backtest, Portfolio 1 did noticeably better than plain 60/40 while Portfolio 2 with value did only somewhat better but my premise is that bonds with duration will not help in the manner they did in the 2000's. IEF compounded at 6.77% in that period which I would not count on happening again, and simulated DBMF compounded at 8.84%.

Putting 40% into managed futures is a non-starter. It did great in the 2000's and while I think that sort of performance would come close to happening again, what if it doesn't? If stocks can't be counted on for a few years then diversifying your diversifiers becomes even more important. 

Yield sources are one way to fill in the gap. For the last ten years, VBAIX has compounded at 9.87% but if equities are lost for a period and bonds end up not being reliable then getting close to that 9.87% is not going to be realistic but that doesn't mean a portfolio can't be productive if equities flounder again. 

Obviously the vast majority of the return has come from yield not growth. Here's how I built it.

Managed futures can do well but aren't yieldy beyond T-bills and merger arb doesn't have any yield to speak of but I think absolute return would be important in a lost decade for equities. The portfolio could be yieldier I suppose but I wanted to have something of a diversified portfolio and I think 50% in funds that don't completely sell out for yield accomplishes that. The portfolio is a little heavy in credit risk which could be diluted a bit with the breadth of today's products. The current 3.13% yield from SCHD is nice of course but that pick is more about a factor that might do relatively well in a lost decade for market cap weighting. 

It has been ages since we mentioned Annaly Mortgage (NLY). It's been around for almost 30 years and the track record is surprisingly strong for something that can't realistically keep up with it's payout.

Yielding 12.28% over the long term, it's only eroded by 2.74% per year. That's impressive. In a way, a lost decade strategy is similar to bridging to the next financial milestone that we talk about every so often. Hopefully a lost decade for market cap weighting doesn't turn into a lost 28 years.

Long time readers might recall that I've had negative things to say about MLPs in the past. I certainly was down on any suggestion about putting 15, 20 or 25% into MLPs as some have said (this was before the financial crisis so probably less of that now) but what I actually said was they should not be expected to magically go up when stocks go down and I still feel that way but they can be plenty yieldy. Correlating to equities that don't do much while kicking out a high yield works in this context. 

I used QYLD for this exercise for the sole reason that it has a long track record. Derivative income funds have evolved to do a better job of compounding positively than QYLD or XYLD have been able to do. Derivative income will not be able to keep up with their reference indexes which needs to be understood. The scenario we are building looks for yield and even a little bit positive growth on a price only basis would be a win for this part of the strategy. The growth would more likely come from SCHD or a similar fund and managed futures. 

Portfoliovisualizer gives a better picture of the yield versus simpler 60/40.

The starting point in 2017 assumed $400,000. Taking all the income out would leave the portfolio at $490,000 as you can see which would not have kept up with inflation. That it didn't compound negatively on a price basis seems like a positive and FWIW, the total return averaged out to CPI plus 6.23%. 

Repeating, there is far more choice as financial products have evolved. Personally, as I work on figuring out the autocallable space (which wasn't available in ETFs until last year) a 5% weighting there and maybe 2-3% to a crazy high yielder (avoid the most volatile stocks and avoid crazy CEOs) would allow for dialing up the equity exposure some. In the template we're working from, eliminating bank loans and/or MLPs could make room for autocallables and a crazy high yielder while dialing up the equity beta some. This might result in the same portfolio yield with more opportunity for price appreciation. Keep any allocation to autocallables or crazy higher yielders small. 

A little more equity beta is something to consider. If a lost decade includes lower volatility, then that would push option premiums down, everything else being equal, lowering the yields on some of these holdings. If a lost decade includes lower volatility but with higher interest rates, that could help offset some of the premium compression because of the role the risk free rate of return plays in options pricing. This table from Copilot explains it better.

The actual numbers are more of a guess but the directions make sense. I included JELH in there because it's new and I am curious. 

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. 

Autocallable "Terrordome"

Janus Henderson has entered the autocallable terrordome as Eric Balchunas calls it. Janus has two funds for now, they do something that is unique to the current autocallable ETF market. We'll get to Janus in a moment but want to circle back to the Calamos Autocallable Income ETF (CAIE).

Autocallables are structured notes that pay out a very high yield as long as the underlying index or common stock doesn't go below a certain price or percentage drop. Banks issue these to generate fees and they hedge out their risk.

I am both fascinated by them, they often yield 12-14%, but can't get over the nagging feeling that there's more risk to the story than bad things don't happen until until the underlying index drops 40%. 

After 13 months, I can't imagine there are too many complaints about the result. If the S&P 500 had been flat over the 13 months then the price only return would likely be down by the amount of the distributions. If markets were meaningfully lower, autocallable funds should be expected to have some degree of sensitivity when declines occur and you can see that in the chart. 

CAIE is an income product, autocallables are an income niche. I used Finominal's optimizer to try to understand what it thinks the relative risk of CAIE might be. I equal weighted CAIE, ANGL which is specific type of junk bond fund, CWB which is convertible bonds and USMV which is min volatility equities. I ran the optimizer for risk weighting the four funds.

Again, I optimized for risk weighting. CWB is the riskiest of the four with CAIE not that far behind. For kicks, here's the four funds equal weighted compared to Finominal's risk weighting and VBAIX.

That one may not be too interesting but there you go. 

Back to Janus which listed JELH which is high income and JELM which targets a lower income. The funds being so new, it's not clear what the yields will be. Gemini has the average weighted coupons of the respective autocallables at 12.7% and 9.4%. So maybe those will be close?

The point of differentiation as reported by Bloomberg news and Bloomberg columnist Matt Levine is that the structured notes include crash protection sold to ETF providers that carry 2x and 3x ETFs. If a company drops more than 50% in a day like Lucid did recently with a 57% decline, a 2x fund is probably going to get wiped out. The crash puts as they're apparently called, will cover the difference between 50% and 57% for the fund provider. Buying the insurance prevents the banks' capital from being wiped out, only the people speculating on the 2x ETF.

That's a simplified explanation but this concept seems similar to catastrophe bonds. It's a form of risk transfer which is interesting to me. 

The two funds own autocallables on individual stocks. They own many different stocks in this context not like the GraniteShares single stock autocallable funds. 

Looking at the full holdings, I counted seven banks, the screenshot shows BNP Paribas and JP Morgan. Not all the autocallables have 2x ETFs so they don't all have crash protection embedded. Chevron, CVS and T do not but NVDA, AVGO and PLTR do have 2x ETFs. 

CAIE targets a yield of 14% but JELH might only be 12% combining autocallables and autocallables with crash protection built in. My initial thought is that the Janus funds should yield a little more. Selling crash protection probably dials up the risk a little. It's early days so that initial thought could be wrong. 

Lately I have been thinking about how to adapt the portfolio if we go through another long stretch like the 2000's where the indexes compound far lower than "normal." Making portfolios a little more yieldy, maybe with equity income added in with the straight equity exposure. That's a developing thought but it places importance on learning more about vehicles like these.  

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. 

Sometimes Retirement Planning Is Mundane

Yahoo Finance reports that while the average Social Security payout is $25,000/yr, "more than 4 in 10 workers aged 55 and older expect Social Security to be their primary source of retirement income." Is that a surprising number? Four out of ten? I don't know what I think about that number. 

There were at least two comments that said with no mortgage, $25,000 should be plenty for a single person to live on. Doable? Maybe, depending on where you live but plenty....

I tried to list out our expenses for living in Tucson, projecting forward to when the house is paid off. 

Tucson is not cheap but it is not very expensive either. Because we are there only part time I had to grab some averages for things like the water bill. For just one person, the number drops to $3329.50 (cutting Medicare, car insurance and the cellphone bill in half). What do you think about $1200 for groceries? I didn't cut that one in half, is $600 for one person high or low. I didn't take out the solar lease because without it, the electric bill would be well north of $200.

I realize there are things that might be missing from how other people spend money. We spend nothing on medical care (knock on wood) other than an annual physical. Who knows how long our luck will hold out but at this point there's no way to reliably predict what our spending will require on this front. Gemini thinks that the average annual healthcare expense for a 65 year old is $2691/yr excluding insurance so maybe add another $224/mo in today's dollars. 

There's no money leftover for fun other than streaming, but streaming is probably the first (only?) place to cut expenses from that list. Is never watching anything realistic? Prime is almost free plus one more like maybe Netflix or Hulu without live TV might shave $75-80 off the monthly expenses. Please comment if you can figure how to get to $25,000/yr in today's dollars being plenty but that doesn't seem plausible. 

There's also no money left over for bigger, unexpected expenses like something with the car or house. 

The point is the process not whatever numbers I came up with and again, I am sure I am leaving things out. 

We've had this conversation before. What are your fixed expenses likely to be? What about more lifestyle expenses like traveling (even if infrequent) or hobbies? Looking at bank account statements and or credit card statements can help dial this in. 

Our real number is probably closer to $4500 in today's dollars but doesn't include traveling, other types of fun or big emergencies.

As I say frequently, the Social Security Administration wants everyone to know their numbers. Going with our Plan A for SS (I take it at 70 and my wife at 64), our SS would be $6684/mo, reduced by 23% in case Congress actually lets benefit get cut leaves us at $5146/mo in today's dollars. That looks good unless some sort of medical thing comes along that is continuously expensive out of pocket or there is some sort of scenario that forces our hand to take SS earlier than we plan. 

SS will cover some portion of your fixed expenses, maybe even some of your discretionary spending or maybe covering your occasional emergencies or other big spends. What portion will it cover of those three categories? How much does your portfolio need to reliably come up with to cover everything? 

I think the math is simple. Living a $7000 lifestyle and expecting $4500 from SS (whether you discount it or not) obviously means finding $2500. Got $2 million saved, you're in good shape. Got $500,000, you'd be at a 6% spend rate which would probably survive but is not ideal. 

Depending on how comfortable someone is with their own numbers, SS vs expenses and what they have in the bank, determines whether something has to give like working longer, spending less, taking up some sort of post-retirement side hustle or something else. 

As mundane as that was, something a little more interesting was post by Jordan Grumet. He is in the decumulation phase and not a fan of buckets like segregating a year or two's worth of expenses in cash to manage sequence of return risk. He is implementing what he calls The Never Rebalance Glide Path starting with a 70/30 allocation. When stocks are up for the quarter which is most of the time, he will take his income need from equities and when equities are down he will pull from the fixed income side of the portfolio. 

A couple of comments pointed out that his premise is built upon assumptions of how bonds did for close to 40 years going into 2022 and that 2022 invalidates his idea because both stocks and bonds went down. It's sort of a Karl Popper argument that it only takes one negative occurrence to disprove something. 

Grumet's goal is to make the decumulation process easier. You can decide for yourself whether you like the idea or whether you think it makes anything simpler but Grumet never talked about what bonds he owns. The critical comments make a good point but if you swap out bonds and think in terms of equity offsets whether that's absolute return, gold, managed futures or anything else, then that seems like a better way to think of his idea in case you are not a fan of bonds with duration. 

One last item relating to a different type of bucket, exhausting a bucket or account. One form of this that several clients have done over the years that I thought I would share here is selling a house and investing some of the proceeds while spending down the rest of proceeds. One client just did this, they sold a vacation home and pretty much split the proceeds 50/50 between investing in markets and spending down the other half of the proceeds allowing their investment accounts to grow without withdrawals for a while, probably three years in this example. 

I can see this sort of thing appealing to me. We own a rental cabin that we'll sell at some point. Using the proceeds as a bridge, as we've referred to it before, to the some financial milestone like starting RMDs ties in with my preferences. 

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. 

Wait 10 Years While The Money Triples

Bloomberg has a long read up about what AQR is doing in tax aware long short. It's interesting but the there was one line that ties in with some of what we do here. "Wait 10 years while the money triples." Bloomberg attributed the line to a presentation that AQR gives in promoting the strategy. We'll get back to that in a minute.

Torsten Slok wrote that the 60/40 Portfolio is no longer working. That's not a new thought but he added a little nuance citing that the concentration in equities is or will be a contributing factor to that outcome. The concentration is of course in tech and tech adjacent stocks which depending on how you count is about 50% of the index. 

Have you heard about the large wave of debt issuance from hyperscalers and the like? Early on Monday I was looking at bonds for a new account and Fidelity's inventory was heavy in tech sector bonds. Gemini thinks that the LQD ETF is now 13.2% in tech company bonds with 7.7% of the fund in hyperscalers alone. Five years ago, LQD was 7-9% tech and 2-3% in hyperscalers. The term hyperscaler existed five years ago but was not used commonly. 

The second paragraph of this potentially threatens the equity portion of 60/40 and while we've long talked about interest rate risk threatening the fixed income portion, the tech sector build up in funds like LQD is another one. 

If any of that is plausible to you, what are you going to do? The context of these sorts of comments tend to be in terms of lost decades. The most recent one of those was the 2000's and while markets had a bumpy round trip to nowhere, there were ways to grow portfolios. The way that fund sophistication has evolved, there are now many more alternative ways to grow portfolios than 20 years ago in case "lost decade" actually happens. 

There are several ways to go. One is just staying old school stocks and bonds in a 60/40 allocation or some other split, going all alternatives that can do decently independent of whatever is happening in markets like catastrophe bonds or combining the two or in our case, dialing up the alt exposure some while maintaining some basic exposures too. 

Everyone might come to agree we're going to have a lost decade but what if that is wrong. If it is wrong, and to be clear I have no idea what will happen, then equities will be the thing that consistently does the best and having no exposure would turn out to be a terrible mistake. 

Even if it is a lost decade there will still be plenty of pockets that do just fine or maybe a little better than just fine.

Here's a stretch were foreign had close to "normal" returns in a lost decade for domestic.

Materials did noticeably better than market cap weighted in the 2000's even if not really a normal sort of return.

Compounding at 4.77% is obviously a whole lot better than negative 0.91%. We talk frequently about the Merger Fund which I've owned for clients for ages, in the above period it compounded at 4.66% which is not too exciting during the good times but is pretty strong for a negative period for equities. Gold compounded better than 14% in the 2000's and simulated DBMF for managed futures annualized at 8.44%.

The list of things that can do better in a lost decade is much longer than it used to, repeated for emphasis. Yes, more choice is better of course but a longer list means not having to load up on just one or two things. What if we do have a lost decade for stocks but gold does even worse than stocks in the scenario? It could happen and having 25% in gold if it did would be very regretful.

When anyone talks about all-weather, this is what they are talking about. A portfolio that is able to adapt to whatever comes along. We have a lot of fun, I have fun anyway, building portfolios that might appear to be robust but really are not. They are templates for robustness, yes but 25% in cat bonds or 30% in managed futures is loading up on risk. 

There is something intellectually satisfying thinking you could defeat all macro obstacles with just three funds but you can't. Maybe the combo of momentum, managed futures and cat bonds will never face the consequences of loading up that way but you'd still be taking a lot of risk. A 5-8% weighting (a little bigger than I usually go) not working when it should is much more of a nuisance than a calamity. 

Back to waiting 10 years for your money to triple. At a compounding rate of about 11.5% your money would triple. Maybe that can happen or maybe it will take 15 years at 7.6% which doesn't seem so bad or maybe it will compound just under six percent and take 20 years to triple. But it will happen, the tripling in ten years comment is about just letting the portfolio/strategy work. Another Munger quote was that the first rule of compounding is to never interrupt it unnecessarily. 

Putting 40% into one fund (other than the broadest index fund) and the rest into two or three alternatives is compounding interruption waiting to happen. 

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 Perfect Stack

A good follow up to yesterday's post about portable alpha is a research report from ReturnStacked that tries to find the optimal stack (layering of alternatives on top of equities and fixed income using leverage). ReturnStacked certainly gets credit for creating awareness of portable alpha and capital efficiency and their content is always interesting. 

That image is a good TLDR from the paper. 

The weightings appear to be risk parity-influenced. Finominal's risk weighting optimizer comes up with slightly different numbers but it's not that far off. This can be modeled out on testfol.io and playing around with it some, gives interesting results. 

The equity component is just SPY, I used IEF (simulated) for bonds, GLD (simulated) for gold, DBMF (simulated) for managed futures and the merger fund. I chose those simply to get the longest backtests, testfol.io can simulate certain things to go back pretty far. 

For Portfolio 2 I pretty much cut all the weightings in half other than equities which I reduced by 1/3. The reason to try it with no bonds in Portfolio 3 is because the time period they studied, 1999-2025, benefitted considerably from the bond sleeve up until 2021 in a manner that I don't believe can be repeated. 

The returns are adjusted for inflation, those are real returns not nominal. I adjusted them for inflation to continue the thread about CPI plus 5%. Getting CPI plus 4+% with 1/2-2/3 the volatility and downside of plain vanilla 60/40 without too much effort is impressive. 

For one other comparison, I think the Permanent Portfolio Mutual Fund (PRPFX) is worth mentioning. For the period we studied for this post, PRPFX had a real compounded return of 5.88% with volatility running at 10.07% and a Sharpe Ratio of 0.68. 

Obviously, the ReturnStacked guys believe in leverage but it is a complexity that I would prefer not to take on. I realize they say they are not misusing leverage, I'm sure that's right, but that doesn't mean that something unforeseeable can't happen that causes the leverage to malfunction. 

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.