Problems That Will Never Be Solved

Yahoo hit on a subject that has been happening more frequently lately and that we looked at just once, the extent to which increases in Medicare more than offset the COLA bump to Social Security. As a made up example, maybe the COLA for Social Security is $50/mo but costs for the various Medicares go up by $70/mo.

The way things have gone, there is visibility in subsequent years for this to become a bigger issue meaning that in my example of a $50 COLA, Medicare goes up by $80 in the next year and then $90 the year after. 

My own take is that Obamacare accelerated the implosion of the healthcare system and we've made no progress in all these years to actually fix it. When Obamacare was first rolling out, one of the big arguments against it was that what they really wanted was single payer like other countries. Regardless of whether you think that would be a good thing or a bad thing, it is now so fouled up that single payer might be the only option. 

I don't know whether there is any will amongst politicians or voters (in terms of majorities) for such a thing and I don't know how I feel about it, I am simply saying we may have painted ourselves into a corner on the issue. 

The article said that premiums plus out of pocket costs total 1/3 of Social Security income and 1/4 of all income. “Retirees get this because they’re writing the checks now, but those nearing retirement need to realize that this is coming up,” That's a useful quote. Gen-X needs to start to understand this. 

What happens to your financial plan if half of your Social Security goes to Medicare premiums? Maybe that sounds ludicrous, but what if that happens? Is that a big problem, little problem or no problem? For readers of this blog, maybe this threatens margin of safety. If you're reading this, you probably have some sort of investment portfolio that will kick out an income stream plus whatever you are due to get from Social Security. 

Someone counting on $5000/mo in today's dollars from their portfolio and $4000/mo from SS might have to figure some things out if Social Security actually gets cut (don't forget about that threat) and then Medicare inflation continues at a higher rate than the SS COLA. Expecting $4000 might turn into getting only $2000. 

Here's a clip on Twitter of Dr Oz saying how much the country would be helped if people work one more year. The comments were generally pretty angry in terms of saying the middle and lower classes work longer to benefit the wealthy (read them yourself and see if you take a different message). The Yahoo article talked about delaying Social Security to get a bigger benefit which is always met with angry responses on these articles. 

What is your situation? How comfortable are you about your Plan A working out the way you want it to? Do you want or think you need a Plan B or Plan C? Forget the injustices and unfairness of the system because chances are we are all going to (hopefully) grow very old and then die without any of these problems ever having been fixed. 

So if the system won't get fixed, then we need to solve our own problem and we probably need to start working on that now if you haven't started already.

Part of the solution for everyone should be health. I try to avoid broad everyone should types of comments but is there anyone who thinks they should let their health go? People do let their health go of course but I don't think anyone would say that's a good idea. 

Copilot found studies that say the average 70 year old takes 4-5 concurrent prescriptions and goes to the doctor 4-7 times per year. A few good habits can push those numbers back to 80 or maybe even older which would make the decade of 70-80 much easier and much cheaper. 

Are you going to work? If yes, what will you do, stay at your job or find something new? Will you take Social Security early or will you wait? Do you have flexibility on spending needs/wants? Should you downsize? How much are you likely to have accumulated in your accounts when you retire? It that amount just enough, more than enough, not enough? 

Those are some of the questions to consider. This will not be a fun exercise. It involves exploring what maybe has gone wrong in the past or might go wrong in the future. Confronting those sort of things doesn't sound fun but is important. 

Let's finish on a lighter note, the documentary about the ABA called Soul Power came out on Thursday.

If you're a basketball fan and don't know about the ABA, I'm halfway through the second episode and it is fantastic. It's on Prime. Then after the documentary, get the book Loose Balls by Terry Pluto. The stories are fantastic. Marvin Barnes and the time machine, the Baltimore Claws, the story behind Julius Erving going to the Nets, the Lew Alcindor story, the Silna Brothers, Connie Hawkins, Darnell Hillman, I can't tell you how much fun this is. 

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.

Getting AI To Fall In Line

Barron's had a short profile on the recently listed iShares Systematic Alternatives Active ETF (IALT) which is similar compare to the longer tenured Blackrock Global Equity Market Neutral Fund (BDMIX), same managers running a slightly different strategy.

IALT is running three strategies, one is market neutral, the second is a "dynamic" macro strategy and the third is long only. The three will be combined such that the volatility will be in the 7-9% range. 

You can see the comparison. The idea with Portfolio 4 is that HFGM leverages up so I wanted to get a little closer to apples to apples with IALT. Portfolio 5 is a build it yourself version (maybe) but the volatility is way too high at 14% unless...

...you go further back, subbing in QGMIX for the newer HFGM. Portfolio 4 tries to tamp down the  volatility to be closer to BDMIX (cousin of IALT).

The performance of BDMIX is suspicious, trading flat and then turning up so markedly. Copilot said it was not a change in strategy, the fund started to do better because the various factors and markets it tracks began to do better so it is a function of patience paying off. 

The blend of momentum, macro and market neutral from Portfolios 2 and 3 in the longer backtest looks pretty good over the longer period but it differentiates from VBAIX by quite a bit. The extent to which that is a good thing versus a challenging thing is a toss up. In 2019 VBAIX outperformed by 850 basis points while in 2021 it outperformed by 700 basis points. That gets made up for and then some along the way but a point we've made before is that differentiation can be difficult emotionally which is worth remembering before building something that gets too far away from plain vanilla. 

Copilot likes the blend of those three funds, it notes the biggest risk would be some sort of event that simultaneously hurts risk assets like SPMO, "cross asset macro signals" impacting QGMIX and what it calls deal flow for ARBIX but when I said that ARBIX is more of a relative value strategy, Copilot softened up on that point. 

It said the biggest thing lacking from the portfolio was convexity which to me sounds like client personal holding BTAL. It didn't love BTAL, ranking it third best after managed futures and funds like SWAN which is mostly treasuries with long call options. SWAN should go down less than equities but get a kicker from the calls when equities rise. BTAL helps with SPMO but wouldn't protect against things going wrong with QGMIX and/or ARBIX.

Copilot then laid out ten macro strategies to stress test the portfolio but I am not confident it did it correctly. It included examples from 2017, 2018/19 and 2022 that could be bad for the portfolio but it did well in all of them. I pushed back on that and it rationalized that it was more of what could have gone wrong but didn't. 

This post has a couple of instances where AI gave an output that didn't quite seem to be correct. I've been asked questions about how to use AI and part of my opinion is that it is important to question outputs. It will go back and rethink answers which makes for more productive work. 

SPMO, QGMIX and ARBIX are all in my ownership universe. 

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.

Their Model, Our Funds

Alpha Architect Tweeted a link to its model portfolios. They are essentially the same batch of funds in different weightings depending on the asset allocation. So 90/10 has 35% in the S&P 500 while the 10/90 has about 4%. The models allocate between equities, alternatives and fixed income. There's no login required so I think sharing the details is ok.

Everything in the replication is in my ownership universe except SHRIX while CAOS from their model is a client holding. 

Their model has done very well. I think the only difference between it and the replication is QMOM and IMOM which target something called quantitative momentum. I added those two funds to the backtest to try to illustrate the challenges of holding them. The drawdowns tend to be pretty big and IMOM's outsized growth rate occurred just since November. A less impactful difference (probably) is the heavy exposure to SCHR which is a Schwab treasury ETF that has lagged our fixed income substitutes. 

I thought I wrote about this model before but couldn't find it in the archives, Copilot couldn't find it either.

If we replace HIDE in their model with Cambria Trinity which is think is similar in terms of a lot of trend and volatility, we can go back a few more years. 

Their model clearly outperforms VBAIX but with roughly the same volatility, probably because of QMOM and IMOM. I think their concept is well put together, this is just another example where we can learn from someone else's valid concept and marry it with our own ideas. 

I'll close with a quick bit of capital efficiency history.

Corey concedes that his mention of QDSIX might benefit from hindsight bias.

Portfolio 3 just kicks out GOVT and replaces it with QDSIX, so no leverage in the portfolio other than the extent that QDSIX might use leverage. QDSIX has done much better than GOVT with only slightly more volatility. We've mentioned QDSIX a few times over the years but Portfolio 5 better captures the approach we've blogged about here. 

Most of the people talking about capital efficiency and products providing access rely on plain vanilla bonds with duration but as we've seen countless times, a similar effect can be created without the complexity of the leverage or the volatility and unpredictability of the duration. 

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.

Scathing Rebuke Of Bitcoin

Larry Swedroe went off on Bitcoin. His substack post reads like he's angry. There are some points I agree with and some points I do not. 

The most recent decline, Larry says, proves that Bitcoin is not an inflation hedge in a time when reported price inflation is running above target and while gold is doing so well. 

The table only goes back five years and it takes in the recent crash through yesterday. Since Bitcoin's inception it has compounded at 137% versus 9.8% for gold and 14.8% for the S&P 500 while inflation has gone up by 2.58% annualized. 

There's nugget about Berkshire Hathaway that if it fell 99% it would still have outperformed the S&P 500 since Warren Buffett took over. Applying a similar thought to the price of Bitcoin, I asked Copilot how far would it have to fall in order to have merely doubled the rate of inflation since its (Bitcoin's) inception. Copilot said Bitcoin started at a nickel and that if the price fell to ten cents, "yes ten cents," it would still have doubled the rate of inflation. Based on the testfol.io data to Bitcoin's inception, that tracks but let's assume Copilot is off by a magnitude of 1000, it could drop to $100 and still be far ahead of inflation. 

Point conceded that holding it since inception is not realistic but I believe the five year table is realistic. 

Larry says it's not a haven. I can probably get on board with that because it certainly is not reliable. In 2022, testfol.io has inflation running at 7.04% and Bitcoin up 57% that year. The next year, inflation clocked in at 6.46% while Bitcoin fell 63%. The latest decline doesn't prove anything in terms of it being an inflation hedge. A four month spell doesn't prove or disprove anything. What if four months from now Bitcoin is at $130,000? 

He's correct about the relative lack of history. Fifteen years is not nothing but pretty much is nothing compared to gold. He also talks about the touts constantly reinventing the narrative which they do, I think implying charlatanism. I don't know how you observe Michael Saylor and not conclude he's a charlatan. All of the negatives can be true but it still can protect against inflation. Is the current decline in Bitcoin much different from gold's decline starting in late 2012 when GLD fell from $170 down to $106, 39 months later?

Inflation compounded at just 78 basis points in that period while gold negatively compounded at 13%. How about the period from August 2020 to October 2023? Inflation ran at 5.61% annualized while gold negatively compounded at 2.86%.

I agree with Larry on most of his points but not the big point. For my money, Bitcoin has never been anything but asymmetric opportunity but it clearly has protected against inflation even if it never does so again and four bad months proves absolutely nothing (repeated for emphasis). 

A pivot to a very academic article from the ReturnStacked guys taking the other side from me about adding duration to a portfolio. The conclusions rely on how things should work in a manner that I am not comfortable doing. It starts out acknowledging that in the current "flat term structure" it is "tempting to see duration as uncompensated risk." We've obviously been using that phrase for quite a while. 

This is rebutted by saying "misses a crucial point: bond yields act like gravity for long-run returns" and then that idea is defined in detail. "As yields rise, they drag present returns down but simultaneously lift forward-looking expectations. In many ways, all changing yields really do is push and pull returns across time." Cool if you agree and it is academically correct but I think of that as being pretty oblivious to having money already exposed if yields continue to rise. If you buy a ten year bond yielding 4% and then prevailing rates move up to 5%, the price of the bond will drop about 9%. For a 20 year bond, it will drop about 14%. 

There was then a long discourse about the role of inflation expectations in bond pricing. Academically important but how wrong did that turn out to be from the late 2010's on? 

The paper delved into the folly of trying to predict what interest rates will do. Agreed. But back to the idea of adequate compensation for the risk taken. Believing that 4% is not adequate for ten years is not an attempt to predict interest rates. I have no idea if ten year yields will ever get to a point where the compensation is adequate but 4% is not for me. If that is adequate for you, then you should take it. 

Reading through, there is a tremendous reliance on bond markets doing what they should as I would phrase it which is not a bet I would make with my money or client money. 

I'll close this out with the paper's shift to implying that bonds are the only diversifier versus equities. They obviously don't believe that but the paper took a very binary approach, bonds or nothing to diversify. They say there is a need for different return streams which yes, we have found many to blog about and that I use for clients with volatility profiles that I think people want from bonds as well as yields (in some cases) and total returns (in other cases). 

I've been using bond substitutes for a very long time which does not make the process infallible but long term readers have seen the thought process come together and then get implemented. There's probably not much of an academic rebuttal to what ReturnStacked is arguing but I've been at the very least, grossly underweight duration for 20 years, avoiding it entirely along the way. Twenty years is a long time in relation to a normal retirement span and even a normal career span for a portfolio manager. 

Yes there are certain functions and attributes bonds should provide but I would not tunnel vision on how things are supposed to work. 

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.

Stop Fidgeting

We had a structure fire this afternoon, right after the market closed so this post will be very short. Not much drama in the picture, the fire was contained to the chimney and was knocked down very quickly.

But I do have an analogy between fire trucks and managing an investment portfolio.

The red fire truck is just over eight feet wide, accounting for the mirrors, it is between nine and half feet and ten feet wide. The door right behind it is 12 feet wide. Once you line the truck up correctly, you can back right on in very easily. 

Someone new tried to back it in the other day after our regular training and was fidgeting with steering wheel so much that they were way off center, making putting the truck away much harder than it needed to be. 

Once you line up your portfolio correctly, it will get you where you need to be. Constantly fidgeting with the holdings, trying to optimize for the thing that just happened will make participating in the market much harder than it needs to be. 

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 Legend Of The One Fund Portfolio

Meb Faber's most recent podcast had a couple of interesting things to say about trend following and one thought provoking idea that we've hit on few times here too. 

"Trend is the premier diversifier" for a diversified portfolio and he talked about allocating more than what I think we usually talk about here. The Cambria Trinity Fund (TRTY) allocates 35% to trend. Not allocating enough to trend is one of the biggest mistakes investors make he said. Trend doesn't have to just be managed futures for this conversation, it can also include the momentum factor for equities. There have been a lot more managed futures funds getting listed but also more equity momentum funds too including one from Motley Fool with symbol MFMO. I mentioned MFMO because right or wrong, I associate quality and value with Motley Fool as opposed to momentum.

An interesting tidbit was the belief that "trend chops off the left tail but also gives exposure to the right tail" which I took as being more about managed futures that equity momentum. What that means is that managed futures should protect against extreme negative events (the so called left tail) while benefitting from extreme positive events, the right tail. 

Basically Meb was saying that managed futures can get you out before there is crisis and continue to hold when a market, like gold or silver until a week ago, is rocketing higher. This left tail/right tail idea can be true at times but it has also failed plenty of times. If gold peaked a week and half ago and is now going to revert to some sort of mean that would presumably be much lower from the $5600 peak then I would expect most managed futures to ride gold back down if some sort mean reversion happened quickly. Most managed futures programs have slower signals, 10 month moving average is a common one for example. I'm not trying to predict a fast decline for gold, just pointing out that if it happens, managed futures is unlikely to have gotten out. Maybe some sort of risk weighting and/or position sizing process would be a differentiator of returns across different funds though, in a large gold drawdown.  

If you lean toward Meb's belief of tiling higher to managed futures, I would suggest owning several different funds. An easy way to differentiate would be to have one fund implementing a full managed futures program and one fund that was a replicator. I plugged KMLM, DBMF and AQMIX into Grok and asked how they differentiate risk weighting and position sizing. KMLM replicates using 22 markets while DBMF replicates using 10 markets. Grok actually had a lot to say about the differences between the three so this is doable if, again, you want a large allocation to trend. 

There was a quick mention in the podcast about one fund portfolios. We've looked at this idea before so I was curious to hear Meb's thoughts but they didn't really explore it with specific funds. It is intellectually appealing to have just one fund truly be all-weather giving a real return (inflation plus X%) of more than 2% while being robust in the face of market turmoil. 

One way to think about what would be ideal is to net out a result that exceeded the inflation rate plus a 4% or so withdrawal rate. That's not really about beating the stock market or even keeping up with it. Yes, some sort of diversified equity fund like domestic ITOT or global ACWI should annualize out above the inflation plus withdrawal hurdle but equities won't be robust in the face of market turmoil. They would be market turmoil.

A few weeks ago I asked Copilot and Claude to each construct a portfolio comprised of SPMO, GLD, AQMIX, ARBIX, CEFS and SHRIX that equalweighted the funds by standard deviation and kurtosis.  I got the following result.

The backtest looked pretty good. Since then we had the panic down in gold but the results still look good YTD despite the larger decline....because of the gold directly but also in AQMIX. Make of that what you will.

I circled back to this based on the idea of a one fund portfolio. Is there one fund that might best capture the attributes of the portfolio that equalweights standard deviation and kurtosis. The portfolio is pretty robust so maybe there is a single mutual fund or ETF. 

Copilot's first answer was AQMIX. It offered some other funds too which matters in that Copilot didn't feel constrained to just the components of the portfolio. The other suggestions were client/personal holding BLNDX and AQRIX which is essentially risk parity. Based on thinking it knows me, it thought that BLNDX would be the best choice I could make. 

That's funny on several levels including that at one point I said BLNDX is probably the closest to a single fund portfolio I'd ever go. Keep in mind, Copilot might have read the post in which I said that.

Inflation compounded at 3.88% in the period studied. I threw in TRTY guessing that it would be Meb's contribution to the one fund portfolio discussion. Yes it is only six years going to BLNDX' inception but in that period, Copilot's portfolio (my names, its weightings), AQMIX, BLNDX and VBAIX all cleared the 7.88% hurdle (inflation plus a 4% withdrawal rate). 

As a single fund portfolio, BLNDX clearing the hurdle by 264 basis points compounded, with a lower volatility is impressive. 

To the other point about chopping off the left tail while maintaining the opportunity to get the right tail, a lot of images coming.

First Copilot's monthly bell curve

AQMIX

BLNDX

I'm not sure I would pound the table on chopping off the left tail but there is something to it. I think Copilot does chop off the left tail pretty well but based on the monthly distribution, it seems to also chop off the right tail which is corroborated by the volatility numbers and the standard deviation numbers which although not shown are about half that of the others. 

I feel no push to ever consider a one fund portfolio but teasing out some all weather attributes is productive. BLNDX should be all weather to some extent versus a technology fund or some other volatile equity sector fund. Understanding what various holdings should be doing and how close they are to trading inline with those expectations is pretty high on my list. 

A final point is with any sort of portfolio strategy, there will be years where whatever you are doing will lag, maybe by a lot. BLNDX lagged VBAIX by 600 basis points in 2025 and almost 1200 basis points in 2023. 

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.

Deconstructing Autocallables

Earlier this week, I spent some time trying to dig in more to autocallable ETFs with the help of Copilot. The basic idea is that autocallables have been around for a while as structured notes, an investment product, that tend to have high yields and last year, they started to become available via the ETF wrapper thus democratizing the product. 

We've looked a few times at the Calamos US Equity Autocallable Income ETF (CAIE). The very basic idea is that it pays 14% annually (it's a monthly pay) so long as the reference index does not decline 40%. If the decline is that big then payments are suspended until the underlying index recovers back above point where it breached 40% down. I remember from the presentation when CAIE first listed that there was only one instance where the index went down such that payments would have been suspended. 

CAIE owns 52 autocallables with one coming due and getting replaced in the fund every week which can reduce volatility some. 

It's not even a year yet but you can decide for yourself what you think about it. My hang up has been that I don't think I really understand the risk here. A 14% yield in a 4% world has risk. It's not that no one should take the risk but I don't believe in taking risks that I don't understand. I may have made progress with Copilot. It was kind of a long back and forth but it was productive and hopefully I can convey what I think I've learned. 

I'll include tables from Copilot but the TLDR is that although they continue to pay out as long as there is not a 40% decline, the price will be sensitive to price swings in the reference index which is a derivative of the S&P 500. 

This next one makes them seem very complex.

The prompt for me to do this was that GraniteShares launched autocallable ETFs for two stocks, one tracking Tesla with symbol TLV and the other tracking Nvidia with symbol ANV. I made the obvious observation awhile ago that this sort of thing would be coming and that it is something we should try to learn about. 

Copilot said the "structural mechanics" of TLV and ANV were the same as CAIE other than using individual names for the reference securities. It said the yield on TLV and ANV wouldn't be higher than CAIE. I pushed back on that because by definition there is more risk in a stock than an index so the compensation for the autocallable tracking stocks should more. 

First it agreed that you'd expect higher yields but...

What it really meant was that the yield will be a little higher with TLA and ANV but not enough to compensate for the volatility and risk of the underlyings.

Copilot thinks that TLA and ANV will "carry 2-4x the risk of CAIE but only offer 1.2x the yield of CAIE."

Hoo boy. So I asked if the GraniteShares concept would make more sense with less volatile names like maybe Microsoft and Alphabet. 

Using lower‑volatility stocks like Microsoft or Alphabet would make the GraniteShares autocallable concept materially better — but not for the reason most people assume.
It’s not just “lower vol = safer.”
It’s that autocallables behave non‑linearly with volatility, and MSFT/GOOGL sit in the sweet spot where the structure actually works as intended.

That's really quite an indictment of TLA and ANV. It goes on to say "bad tradeoff" describing TLA and ANV. Using MSFT and GOOG has volatility characteristics that would make the autocallable behave more like it's supposed to behave, it said. 

Alright, I guess Copilot is not a fan. We're going with the idea that Copilot is correct.

While I still am not so intrigued that I want to step into CAIE, knowing there is downside sensitivity helps me understand a little better. I am not saying Calamos said there would be no downside but I don't recall it being discussed.

The reality is that CAIE will "work" the vast majority of time but not feeling like you fully understand what can go wrong makes it a difficult hold even if we understand a little more than we did before. 

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.