Risks That Don't Need To Be Taken

The situation with Blue Owl seems to be getting worse at an accelerating rate. We mentioned it quickly last week when they halted redemptions with a "retail based private credit fund" but the stock continues to go down. Here's more from Yahoo and Bloomberg.

Private credit and equity have been showing signs of excess for a while. It's not clear to me how serious the excesses are but there has obviously been a big push to make private assets available in more retail accessible funds and retirement plans. I've been consistent for years in being skeptical of these type of investments, I don't believe they will give the great deals to people's 401k plans. If you want to benefit from private assets, I've argued for buying the companies selling the picks and shovels, the fund providers, the ones making the fees on the funds not the funds themselves which are paying the fees.

The history of this group is that when times are good, they are great and when things take a bad turn, like now, the stocks get pounded but they do capture what is going on in the world of private assets. They are now on a run of getting pounded. In the last month Blackstone (BX) is down 24%, Apollo (APO) is down 16% and Ares (ARES) is down 26%. I've never owned one of these. I've never thought about buying one, just making the point for blogging purposes that I believe the management companies make more sense for anyone wanting to access the space.

The reason I don't want the exposure is the complexity of these companies and the leverage. Many of the large banks are similarly complex, maybe more so, and also heavily leveraged. This is subjective but financials (meaning the banks) is probably the most complex of the sectors. It might be difficult to understand the manufacturing process and equipment in the tech sector but I believe the businesses are less complex. 

Given how complex many financials are, it should not be a black swan if this event starting with Blue Owl evolves into something very serious. To be clear, I have no idea but this is space that is prone to blow ups. There's no reason to own something with such a clear path to blowing up or at least no reason to have a meaningful position. I don't think there is asymmetric potential with private credit like there is with Bitcoin. 

Mark Baker, aka Guru Anaerobic on Twitter talks about figuring out what to avoid, via negativa, and this is very important concept in portfolio construction. Avoid can sometimes be too much as opposed to underweight. There are excesses in the AI space too of course but there I'm just underweight. This isn't a riskless endeavor, the conversation is managing risk not completely avoiding it. 

In a similar vein, we're probably all watching the news from Mexico and the apparent impact on Puerto Vallarta which as many have reported is where a lot of American, expat retirees live. Moving to another country for retirement (just a few years or permanently) is something we've been looking at for a while in various places. It is a fun exercise to think about living in another country even if you're not serious about ever doing it (that describes me). 

Quite a while ago I wrote a few posts about Ecuador in this context. I made contact through Linkedin with someone (Edd Slaton might have been his name) who had moved to Cuenca, Ecuador with his wife and had some sort business helping people relocate to Ecuador. Then there started to be political unrest pretty close to the covid outbreak but I think the unrest was more political and focused more in Quito than anywhere else. I reached out to Edd back then to see if Cuenca was impacted but and his wife were vacationing in France and he wasn't sure. 

In the last few months I saw something that gave me the impression he and his wife left Ecuador and were somewhere in Europe. My suggestion has been to not sell your house in the US. Rent it out, have the income stream and a way to come back if you want to or think you need to. I have no idea what the real story is in Mexico but it would not be unreasonable for an expat in Puerta Vallarta to think they need to get out of there when the dust settles. The nature of housing in a lot of places is that if you sell and don't rebuy, you'll get priced out. 

You can always sell later but you might not be able to buy back in later. 

Going heavy into private assets one way or another and moving to another country with no fallback are both examples of things that are easy to recognize as risks that don't need to be taken. 

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.

Navigating Managed Futures Dispersion

Just a couple of quick hits today.

AlphaSimplex has a paper that looks at some serious dispersion in managed futures. 

The first chart shows dispersion between differing signal lengths. We've talked a little about fast signals versus slower signals, I believe more programs lean toward slower signals but either way, fast or slow, they all take turns leading and lagging.

The next chart compares full implementation (wide) versus replication (narrow). To the left it looks like full implementation did better and lately, replication has led. 

The paper thinks the recent outperformance of replication strategies is just random chance. 

There are other factors addressed in the paper that might account for dispersion but I think the bigger point is to consider owning more than one fund. Not necessarily a larger allocation but adding in a second or third fund. AI can help tease out differences in how many markets a fund invests in as well as differences in risk weighting and signal length. 

Barron's looked at convertible bond funds and had this table.

This is an interesting space. The textbook on these is that when stocks go up, converts trade like equities and that when stocks go down, further away from their conversion price, they trade more like bonds. Maybe individual issues, I don't actually know, but the funds usually trade like stocks on the way down too as implied by the 2022 result. 

What's the deal with the Franklin fund listed there? I asked Copilot if it targets a lower equity beta than FCVSX. Copilot said yes. It said the Franklin fund is a more "classic, balanced convertible" strategy where the Fidelity Fund "runs a more equity-forward, higher delta book."

A little longer term, I'm not sure Copilot is correct. When I pressed, it gave what I would say is vague reasoning for why it was correct related to realized betas versus target betas. This is a good example of being curious, getting some AI help and pushing back when it seems off. 

Peter Mallouk Tweeted this out;

While I wouldn't count on a 10% growth rate, it makes an important point. Being a little older and far behind doesn't mean you can't still accumulate a meaningful piece of money. I don't think too many 60 year olds are going to be able to put away $163,000 every year but $31,000 at 50 where both partners make a decent living doesn't seem crazy to me especially if they pay off a mortgage in this window. Even $20,000 a year from age 50 to age 66 at 9% per year would be $666,000 which is enough to create a meaningful income stream even if it is not sufficient to meet all needs. 

Yes, Mallouk used 15 years but if someone is starting from scratch at age 50, maybe they would consider working a little longer. 

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.

It All Comes Back To Optionality

The daily New York Times email led off with a bit about self improvement related to people "doing favors for their future selves." We have been using that exact phrase here for ages. There are big picture applications that we talk about in terms physical and financial benefits but also very immediate but mundane things like backing into a parking spot so it is easier to get out and doing the dishes tonight instead of letting everything sit in the sink overnight. 

Doing stuff now versus having it sitting there waiting for you, more the dishes and pots than the parking spot example, resonates with me. I really dislike having a bunch of work that I need to get done just accumulating, waiting for me for when I probably won't feel like doing it. Note that I don't know if the link will work, it's what came up when I clicked view in browser. 

The writeup was pretty superficial looking first at the emotional tradeoff of making sacrifices now for an uncertain future and then wonder when the payoff comes for doing favors for your future self. 

I figured this out early. Where I think it came from is my grandmother was a great baker. My favorite thing she made was mint chocolate cake with mint frosting. The frosting was the best part and my older siblings always told me to save the frosting for last, save the best for last. I started hearing that at a very young age and so it stuck. Save the best for last made it easier for me to think about favors for my future self along with a few other examples that I won't bore you with. 

It's also akin to playing the long game which has worked out well. From the fire department, I coveted one of these trucks from when the Forest Service first started buying them.

Financially, this was nowhere close to possible, not even a remote possibility for us. It took about 15 years but it finally happened in 2023 and I'm still young enough physically that I'll be operating it for years to come. Then we got another one.

One form of payoff, from this point I will call it optionality, is getting what you want and still being able to use it or do it or benefit from it. This is probably physical optionality.

Another form of self created optionality is either wanting to do something different (work related) or having your hand forced at work without being left desperate and scrambling, forced to do work you don't want to do which is probably financial optionality.

Physical optionality is created by regular vigorous exercise and financial optionality is created by making good decisions related to saving and spending. When I turned 50, I said being that age which implies having some experience, with a little money in the bank while still being able to get it done physically is a great spot to be in and that I imagined the 60's would be the same. I'll be 60 in April and that appears to be panning out which is not surprising. I already pack tested for the 2026 fire season which is the annual physical requirement of hiking three miles with a 45 pound pack in 45 minutes or less. Sixty is old for this but not elite, like many things, success on this front comes from understanding the task and marrying that with your capabilities. 

As far as the time tradeoff, the physical optionality doesn't seem like much of a tradeoff. Go find @mangan150 on Twitter. He preaches only lifting twice a week for about 30 minutes each session and then walking regularly. He also includes HIIT in his lifting sessions too. And for the little time actually needed when done with the right intensity, you're healthier and feel better now, not just in the future. I lift twice a week for closer to 50 minutes and I jump rope almost every day (less than ten minutes). Our dogs don't like to go on real hikes too often but we take them on a mile and half loop around our house that climbs a total 400 feet or 600 feet depending on how we go, we do that pretty regularly. It all takes very little time

Financially I would say living in less house than you can afford and not replacing cars every three years, I've been driving my Tundra since 2007. There is emotional benefit to going through with a little bit of a financial cushion which is a benefit now and in the future. The house angle may not stand up anymore. I perceive buying a house has become more difficult. Beyond the headlines, which I don't know what to make of, I know that were I live there are no more starter house in terms of cost. In terms of size, yes, but not dollars. Tucson has plenty of houses in the $300,000-$400,000 range which is much more accessible for younger people who make a pretty good living even if they're not killing it. 

All of these concepts serve to make life easier. If life is easier, it stands to reason that life would have less negative types of stress like worrying about money which makes life easier (yes that is circular).

Speaking of fire department stuff, we replaced our old brush truck with a new one. 

I may have told this story already but short version, we had to replace the truck. One of our guys had the idea of lifting the pump, water tank and all the rest off the back of the old brush truck and putting it on the new Dodge. This idea probably saved us $150,000. That's the truck, being picked up from getting the graphics applied this week. 

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.

Post 1000 & Risk Management

This is post number 1000 for this URL. My first blog address disappeared (short version) when all of that content, about 4900 posts, was moved over to a site hosted by AdvisorShares when I had my side gig there a while back. I wrote at The Maven for a bit but that sort of sputtered and however many hundred articles I wrote for thestreet.com are all still up.

First up, Corey Hoffstein posted this picture with the caption "as predictable as the daybreak." I think he was referring to a good fund having a long struggle and then doing well again. 

BLNDX is of course a client and personal holding. Yep, it struggled for a while. Any valid strategy will have periods where it languishes. Speaking of AdvisorShares, when I worked there, the CEO was fond of saying that when a manager struggles for an extended period, you should double down. I don't know about doubling down but certainly throwing in the towel runs the risk of being a bad decision. Probably.

The caveat might be a stock picking fund that is always trying to beat the market. The Fairholme Fund (FAIRX) might be a good example here. 

The manager, Bruce Berkowitz, a smartest guy in the room type but this has been a very difficult hold. If you play around with the time periods though yourself, you'll see there have been different runs where it has been closer or even ahead of the index but I'm not sure how you settle in and buy this one. BLNDX is systematic though. The equity sleeve uses index funds and the managed futures sleeve, like I said is systematic and if you've ever seen fund manager Eric Crittenden interviewed, he never second guesses it. 

Here's an interesting idea. 50% BLNDX and 50% gold.

Ok, that's interesting. If you simulate it though by replacing BLNDX which only goes back six years, with a mix of ACWI and AQMIX, you get a much longer backtest that is very unimpressive. Managed futures and gold had rough run for much of the 2010's. Managed futures is great. Gold is great. But don't get carried away.

And in a related article, Bloomberg said At Long Last Being Underweight Tech Is A Winning Strategy. I don't think this is the right thought process here for what has been kind of a sneaky rolling over for big tech. Not so sneaky? I don't know actually but either way, as we've said countless times, history has not been kind to sectors that grow to be larger than 30% of the index. Where most of the revamped communications sector came out of tech, you could argue that instead of tech being 34%, it's closer to 40%.

The risk from a huge sector weighting either resonates with you or it doesn't and this pullback is either the start of something or it isn't, I don't know but I do know that I don't want to chase this sort of thing. I've been underweight tech for a while. Said differently, excesses, like 35-40% in one sector, are prone to real pain. 

I think the most important part of risk management is recognizing it before the consequences hit. That much in tech is an obvious risk factor. Maybe it will never matter, I don't know but it is obvious and one that matters to me. There is no reason you need to be overexposed to the risks that matter to 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.

Halting Redemptions...Permanently?

A couple of weeks ago I got an email promoting the Denali Structured Return Strategy Fund (DNLIX). It's more fixed income-ish, not an equity strategy.

It's a newer fund. We took a look at a few months ago. MERIX is a client and personal holding and I used CBYYX as a proxy for catastrophe bonds because testfol.io didn't have the right data for SHRIX or client/personal holding EMPIX. The general interest here for me is finding more strategies that have the above type of volatility and return profiles but with risk factors that differentiate from other funds I use. 

Related pivot, on Wednesday I sat in on a webinar put on by Nuveen about farmland investing. Similar to timberland, farmland is a fantastic diversifier. Equities/REITs in either category don't capture the effect very well. My belief in farmland (and timberland too) is great enough that I will listen to any presentation that comes my way. Nuveen has a non-traded farmland REIT which is probably surprising, at least to me anyway, and sure enough it does well.

Now this from the FT (everyone else covered it too), Blue Owl has "permanently" halted redemptions from some of its credit funds. Basically, Blue Owl is going to sell down holdings as it can and then return the money in drips and drabs. The implication is it will take a long time.

DNLIX is an interval fund. I already said the farmland fund is non-trade so no daily liquidity there either. 

I have been very consistent in saying I'm not going to go down this road for clients, and that is still the case but as we talk about frequently, all of these things will evolve and maybe farmland or timberland will make it into some sort of wrapper with daily liquidity that captures the effect. Or not, but there is no reason not to follow along for the things that interest you as much as timberland and farmland interest me. 

In the meantime, taking on the complexity, fees and illiquidity of the current wrapper makes no sense to me. Chances are you can find proxies that get 90% of the effect without the complexity, fees and illiquidity. 

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.

Selling Volatility Can Be Painful

It's been a rough go for the Tuttle Capital MSTR 0DTE Covered Call ETF (MSTK) since in listed last fall. It hasn't been much better for the older YieldMax version (MSTY).

If you add the distributions back in on testfol.io, MSTK is down 59% while MSTY is down 46%. The total return declines aren't that bad compared to Strategy's common stock which Yahoo shows down 52%.

Learning how to harness volatility as well as how not to do it has become pretty important to how I view things which is why we spend so much time looking at it here. Frequently, I talk about sifting through a lot to find something useful. That's what looking at funds like this is, sifting through things that would pretty clearly be very difficult to hold but there is information in watching how the crazy high yielders behave. 

Kind of related. Interesting idea, not being sarcastic, but getting hit in not quite a month of trading.

They filed for a whole suite of these but so far just this one and a gold/Bitcoin fund that has symbol ISBG which is down 25% in the same number of days. 

I sat in on a Webinar from WisdomTree about capital efficiency. They included this slide which we looked at a very similar slide a few weeks ago.

If you're interest in looking at that again, there it is but I had a another thought. Meb Faber Tweeted something about 60% S&P 500/40% gold looking an awful lot like plain vanilla 60/40. I couldn't recreate that but this is interesting.

Testfol.io can simulate certain things before when the respective fund actually started including DBMF which is a managed futures ETF. Backtesting managed futures this far back is pretty helpful. 

Managed futures looks more like intermediate treasuries (there is no simulation for AGG) than gold does until we get to late 2021. You can kind of see in the drawdown chart where managed futures worked relatively well when the internet bubble popped and the financial crisis which were both slow moving events, it got hit in the covid crash because that was a fast event and of course 2022 when it did fantastically well.

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 Pursuit Of Robustness

Bob Elliott from Unlimited Funds got interviewed by Brad Roth from Thor Financial which was posted at ETF.com. Bob has a fascinating background, he worked at Bridgewater for a long time and then started Unlimited a few years ago. Unlimited is up to four funds now and all of them offer some version of hedge fund replication. HFND is the original, HFMF is 2x managed futures, HFGM is 2x global macro and HFEQ is 2x long/short. What 2x means in this case is twice the volatility which might equate to twice the return but not necessarily. Part of the idea with these is that many liquid alts aren't volatile enough. 

With his background, Bob should be a great must listen but this interview was the best one I've heard for extracting useful tidbits. 

First, lets test drive 2x managed futures. In the interview, they talked about an allocation of 50/30/20 to replace 60/40 where the 20 goes into alts. 

For quite a while, the managed futures didn't really help much as the teens was a bad decade for managed futures. That struggle didn't really hold back relative returns though. Then in 2022, the managed futures did help both Portfolios 1 and 2. The early lag for Portfolio 1 is from having only 50% in the S&P 500 versus the other two having 60%. If you like the idea of 50/30/20, saying the obvious, you have less in stocks than in a 60/40 portfolio and stocks are the thing that go up the most, most of the time. 

They talked about HFND, Bob's first fund, being something of a fixed income proxy (my words).

Some clients own BALT as a fixed income substitute. The chart is interesting. Going back to QAI's inception, that fund has not done well but that might be a function of rates that were at 0%-1% for a long time. Now that rates are higher, that fund is doing better. I am surprised to see QAI ahead of HFND.

The motivation to use these liquid alts is to make portfolios more robust, the pursuit of robustness. Robustness does not mean perfection which I think is a great point.

The most interesting idea they talked about was that once you find robustness, you're not going to improve much from there. Basically don't mess with it because you'll get either diminishing returns or end up with something that's not as good. 

Interesting, what do you think about that idea? I disagree in terms of there are countless defensive tools available today that were not available when the Financial Crisis started in 2007 for example. Then fast forward to the crisis (small c for this one) for bonds with duration starting in late 2021. If the multi-decade, one way trade in bonds had ended in 2010 instead of 2021, there would have been far fewer fixed income substitutes to use instead of TLT and AGG. 

From my time at Fisher in 2002, they used the term capital markets technology which is what we're talking about. Buffer funds (no matter what anyone thinks of them) are an innovation, a new form of portfolio technology. When I bought RYMFX in 2007, it was literally the only managed futures fund. How often to I mention client/personal holding BTAL? BTAL didn't start until 2012. A few days ago we quoted Shana Sissel from Banrion saying that BTAL and managed futures are the most important diversifiers. 

All of this innovation has meant needing to sell less for defense than I did in 2007/2008. In terms of process evolving, I would rather offset downside with diversifiers than just straight up sell. It's much easier to get it wrong by reducing exposure selling down equities versus adding more negatively correlated funds. 

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.