Less Portable, More Alpha?

Barron's cited research from Edward McQuarrie (we looked at something else from McQuarrie in June) that tried to make the case for bonds instead of stocks. 

No. 

If you want to make a case for including bonds, ok, that's different. I would disagree but including some bonds to offset the ups and downs of 100% equities might turn out to the be the right thing. But that was not the context.  

We frequently focus on how to get the volatility muting effects that people want from bonds without taking on the risk and volatility that is now inherent in bonds with duration. As I started to frame this post out in my head I saw a reference to portable alpha somewhere. 

The most common application of portable alpha is combining beta exposures like an index fund for equities and AGG-like or treasury bond exposure for fixed income and then adding some sort of alpha (outperformance) source in such a way that usually involves leverage. Maybe a program doing this would use S&P 500 futures for equities and the leverage component, maybe actual bonds and then some sort of intended alpha source that after a lesson learned from the Financial Crisis should be uncorrelated to equities like a hedge fund or managed futures. 

Portfolio 1 is an example of success with leveraging up. It gets leverage from SSO which is 2x the S&P 500. IEF is 7-10 year treasuries and the other three are different types of alts that should maintain a low or negative correlation to equities. In real life, putting 30% in SSO and leaving it in there would be a tremendous act of faith. 

The PIMCO Stocks PLUS Long Duration (PSLDX) goes down this road with 100% exposure to both stocks and long bonds. WisdomTree Efficient Core (NTSX) came along in 2018, it's 90% stocks, 60% bonds so a 67% allocation to it equals 100% into VBAIX which leaves 33% for alpha sources/diversifiers. 

Updating the first example to include a version with PSLDX and NTSX;

All three outperformed plain vanilla 60/40 in Portfolio 4 with the PSLDX version having the best growth rate and good volatility result. The version with NTSX has lowest Sharpe Ratio of the three portable alpha portfolios but a CAGR 131 basis points ahead of plain vanilla is pretty good. 

The alts help the three versions outperform a little during adverse market events but there doesn't appear to be a ton of reliable crisis alpha.

In previous blog posts, we've looked at building these sorts of portfolio but without including bonds with duration. For the last few years bonds have of course struggled but that struggle under the hood hasn't necessarily been a problem for the backtests. At least one of the alts (managed futures in 2022 or gold last year for example) helped bail out the struggling bonds during various negative market events. 

Then I found this paper from Man Financial (I'm guessing we looked at it a couple of years ago when it was published too). Here's their take on building an institutional portable alpha portfolio.

Below, I am using AQMIX and QSPIX as proxies simply because they have long track records. Man talked about possibly doubling returns with 100/100 equities/managed futures but I couldn't recreate that. The results are interesting though. 

Moving closer to something plausible. Portfolios 3 and 4 should say 50% SSO not SPY.

All three have 50% in SSO which is the equivalent to 100% in the S&P 500 subject to any tracking issues so the portfolios are 100/50 and all three outperformed with less volatility. They all did much better in 2022 than just the S&P 500 but in the other drawdowns, the fast ones in late 2018, 2020, 2025 and 2026 they didn't help much.

The final iteration is 80/20 and I threw in 60/40 with VBAIX

They lag SPY with quite a bit less volatility. They outperform VBAIX with a little more volatility but their drawdowns have been shorter than VBIAX' which is an interesting tidbit. Is it worth it? The Sharpe Ratio and the volatility numbers suggest it probably it but ultimately that would be up to the end user. 

The bigger point is about how very sophisticated strategies can be adapted to retail sized accounts through regular brokerage accounts and the extent to which alts can help dial in volatility and add defensiveness to diversified portfolios.  

Tying back into portable alpha, I am not a fan of leveraging up to build a portfolio but I think the process we explored takes some influence from portable alpha which I am comfortable with. 

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. 

There's a Munger Quote For That

Some quick hits today.

By now you've probably heard about the hedge fund called Situational Awareness run by Leopold Aschenbrenner. He made an absolute fortune leveraging up to bet on all the AI-adjacent stocks that were leading markets higher before they started to rollover in June. The leverage that made him a genius on the way up destroyed the fund on the way down. 

The Old Rope Research blog was apparently a believer in Leo and then wrote this mea culpa. In there, he called Aschenbrenner Lumpy Leo, referring to lumpy returns and attributed a quote to Charlie Munger about "preferring a smooth 10% return to a lumpy 15%." That is a great and concise way to sum up what we are trying to do here. 

This chart from Bespoke Investment Group is insane to me. 

I may not have mentioned it before but I am not a fan of bond duration. 

Recently, I learned quite a bit about outsourced chief investment officers (OCIO) in my work with the Del E. Webb Foundation. Basically, OCIO is a fancy term for the type of specialized investment manager that is equipped to provide service to foundations and endowments. It may seem like I'm making fun of the term but not the work they do. 

I will have more about this later this summer but in talking to one firm, there was one quip that really made an impression. In wanting to stress the importance of the relationship and services provided, they said anyone can manage the money. 

A quick detour, "relationship and services" is very important, there are complexities that differ from a person just trying to save for and then navigate through their retirement. 

But we can still dissect the portfolios. Typically, there's a lot allocated to equities, 65% was a common number. That 65% would include maybe 10-15% in private equity. Firms will often manage public equity with active managers with maybe a small sleeve allocated to index funds. A common allocation to alternatives as diversifiers other than private equity would also be in the 10-15% range. Based on my small sample size, these firms don't seem too interested in doing much with actively managing fixed income which if correct more universally, surprises me. 

I pulled some information about returns and volatility of OCIO managed accounts from Grok for three years ending 03/31/2026.

There's nothing special about the endowment and foundations numbers. There's nothing wrong with them either but they don't refute the claim that anyone can manage the money.

Portfolio 1 attempts a very generic replication. ACWI at 65% involves two decisions; the weighting which is consistent with what many OCIOs do and including foreign with ACWI as opposed to domestic only. APHPX and QMHIX are intended to be the the alts sleeve mixing something that is hedge fund-ish and managed futures. The income sleeve has a little more thought to it. SRDAX is an income fund but it goes off the beaten path and FLOT requires deciding to avoid duration. 

I couldn't really tease out better OCIO data even trying multiple AIs but if a person working at an OCIO shop says anyone can manage the money and we can get similar returns to what OCIOs can achieve then this supports the idea that investors can get "institutional" outcomes with brokerage accessible funds. That's huge and did not exist 20 years ago. 

The result is a little better than what Grok found but isn't all that interesting actually. It tracks very closely to the more generic Portfolio 2 but with noticeably better compounding and slightly less volatility. Both are valid but not special. Inflation ran at 3.04% so both were better than CPI plus 5% which is good of course but that is a short window we're looking at and stocks did fantastically well over that stretch.

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. 

CPI Plus 2.72%?

There's been a lot of attention lately to real yields on TIPS approaching 3%. These yields that Copilot found are probably stale by a few days but current enough for this post. 

We've talked more about the concept of real yields/return a few times lately. Generically, a real yield of 2% is considered a benchmark or sort of minimum standard. Real yields have been heading in the right direction from the perspective of investors for the last few years based on the UTEN ETF, which is not a TIPS product, but haven't been attractive.

This relates to recent posts where we've talked about foundations often seeking CPI plus 5% for an entire portfolio, the context of this is CPI plus almost 3% for a sleeve of the portfolio. The ten year and further out TIPS are still duration. If interest rates go meaningfully higher without a big step up in headline inflation then the prices of TIPS bought at 5.11% nominal/2.72% real will still go down a lot in price. If rates move higher along with noticeably higher price inflation, then the par value will be reset but it's sort of sequence thing for how much prices might drop as par increases teeter totter with interest rate sensitivities. 

Before going any further, if this sort of real yield appeals to you enough to allocate to TIPS, buy individual TIPS not ETFs or mutual funds. 

TIPS aren't my favorite. We can build a portfolio with a higher real yield that is far less volatile. I built this study;

I included TIP but there's not much information there, the duration is just under seven years. The real yield from the first table for a 20 year TIPS is 2.72%. The volatility of a 20 year TIPS should be similar to a 20 year regular bond and you can see the volatility of TLH which tracks 10-20 years. 

The specifics of the portfolio I built aren't important but a couple of details, 50% of it is FLOT which not a high yielding fund. It currently shows 4.53% on Yahoo Finance. The other half is split between 7 funds which each have 6-8% weightings to dilute the risk a bit. There is some volatility in the yield numbers flowing from the portfolio. 

In the context of CPI plus 5%, despite our result with the above income portfolio that has no equity exposure, you'd need a growth component (equities) to have a reasonable chance for CPI plus 5% for a longer period. 

Maybe you don't need that but if you do, even 20% equities should nudge up the plus X% number.

Adding 20% to equities and reducing the income positions proportionately had a total return for the period study of 11.27% and while that sounds good to me, it compounded 500 basis points less than a simple 60/40 portfolio. 

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. 

A Doozy Of A Day

This is a doozy of a quote from Torsten Slok via Bloomberg.

Here's how treasuries did on Wednesday. 

You can see most of the selling further out the curve happened as Kevin Warsh gave his press conference which was also a doozy. The respective drops in the seven year and five year is obviously less problematic.

Is the market doing the FOMC's job? Warsh sort of said that in the presser

The next batch are semiconductors, then broad tech, the S&P 500 and SPXT is the S&P 500 excluding the tech sector. From their respective highs in June, SOXX is down 27%, XLK is down almost 15%, SPY is down 3.8% and SPXT is down less than one percent from its high which was this month, not in June.

If this event turns out to be serious or memorable (or both), I think today gave a good look of what it will look like. Excess in the AI and AI adjacent space and unreliable volatility in the bond market will be front and center. We've been talking some about the excess in parts of the tech sector and talking constantly about the unreliable volatility of bonds a lot. 

We've had similar conversations in previous big events, I'm not sure what you do if you were overweight tech a month ago with no negative convexity on board. Maybe today is the bottom? At some point, industries like semiconductors, themes like the CHAT ETF or stocks like Oracle will find a bottom, time will bail those holders out eventually, there's just no way to know what they will have to endure or for how long. I mentioned ORCL because the decline has been stunning, I would be shocked if it went out of business at the end of this but to be clear, I am not a buyer at any price. 

I think anyone who was underweight tech coming into June, no tech is not realistic, and has been avoiding fixed income duration will fair better through this, if it turns out to be serious, but I would not count on skating through with no decline. My hope would be to avoid the worst of it. My experience has been that avoiding the worst of these events is repeatable. 

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. 

Should We Optimize For Sharpe Ratio?

Franklin Templeton is an ETF provider that gets very little attention. They do some interesting things and they also have model portfolios to support their funds. 

It's a 10/90 but it's not intended to be a standalone portfolio. As I take it, it could be used as a fixed income replacement along the lines of ProShares Hedge Fund Replication (HDG) or NY Life Hedge Multi-Strategy Tracker (QAI) as suggested by Claude. 

First is how Franklin model compares to HDG and QAI.

IUSB is similar to AGG but a little broader and has done slightly better that I will plan on using for blogging purposes going forward instead of AGG. The model took a less volatile path to a similar result as both HDG and QAI. A quick note, I switched out ARB from the model in favor of MNA to be able to go back a little further. If you look at the performance numbers, they fair worse than what I got because I am only able to grab what is in the model now, not track the changes it made along the way. 

Building the model out to a 40% weighting with 60% to equities, certainly helps the growth rate versus putting the 40% in IUSB but doesn't help much with volatility. Other than the 2020 Pandemic Crash though, the model has consistently done better in drawdowns. 

Here's a four minute excerpt from a podcast featuring Cliff Asness. The key line from Cliff was "you need to be able to short sell to create an uncorrelated return." QLEIX below is long biased, MERIX is market neutral and BTAL is short biased.

MERIX is client/personal holding the Merger Fund and ok, that might be the correlation but take a look for yourself, I would say it looks nothing like the stock market. It's by no means negatively correlated but regardless of the stats, having held the fund since the Financial Crisis, for my money it does not behave like the stock market even a little bit. 

Cliff also talked risk parity weighting of assets without using the term risk parity. He talked about leveraging up to even out the risk taken between assets with low/un/negative correlations. 

The holdings are SPY for equities, IUSB for bonds, AQMIX for managed futures and GLD.

It is very amusing that the way to optimize risk adjusted return (Sharpe Ratio) is to have no AGG-like bond exposure. Interestingly, if we replace IUSB with MERIX, the Optimized Sharpe Ratio recommendation was 25% each to SPY and AQMIX, 30% to MERIX and the rest in gold. 

Other than the Pandemic Crash, Optimized with MERIX has been a very smooth ride.

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. 

Additive To Your Long Term Result

Here's a quote from Jonathan Hoenig;

The best portfolios are designed to protect capital first while pursuing steady, absolute returns over time—not reacting to every market swing.

From Stephen Harvey of Sagard Wealth;

And Matthew Tuttle. 

You've been hearing for years about ETFs democratizing access to various strategies, including from me. I think the ETF industry has forced the mutual fund industry to also up its game. If you've been reading this site for a while then you already have at least a start at knowing how to do what all three quotes are talking about. 

The underlying premise connecting all three quotes is how to avoid making behavioral and allocational mistakes. One way to do this is to avoid obvious signs of excess. I've got some track record for this with banks in the build up to the Financial Crisis, bonds yielding nothing as Tuttle says and now with AI and AI-adjacent themes. 

There were enough non-bank financials 20 years ago (more now) that being slightly underweight the sector while avoiding banks almost entirely (held on to BNS which clients still have) wouldn't have been too disruptive if there'd never been a crisis. There were/are countless alternatives to bonds and bond funds with duration that would do what I think people want bond and bond funds to do, we've looked at this countless times. Completely avoiding tech today is impractical, it's too big a piece of the market to be zero weight. 

I think being underweight or avoiding excesses is easier than picking what will do best. Occasionally sidestepping an implosion, so not even every implosion, will be very additive to your long term result. 

The link quoting Harvey is from Chief Investment Officer and while I am unfamiliar with Harvey and his firm the context is institutional portfolios. The strategies and exposures he is talking about can be found with an abundance of choice from mutual funds now and to a lesser extent, ETFs. Quick note, pound for pound, ETFs are the better way to go but not everything goes best into the ETF wrapper.

Harsh closeout coming, too many people in the industry are still talking about and using very plain vanilla fixed income products that simply haven't been doing what investors would hope for and expect (repeating for emphasis). 

I've put up similar versions of this chart many times before, what do you want your equity offset, let's not called it fixed income, to look like. I think to avoiding duration will continue to be very additive to your long term result.

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. 

Don't Focus On What You Can't Do

The starting point for today's post comes from a couple of different articles at the Wall Street Journal. The first one is about the retirement situation in Thailand. If you think the US is in rough shape, Thailand appears to be far worse. The equivalent of Social Security pays $18-$35 per month. 

That sounds low but there was no context around those numbers. Grok says a "frugal/basic" lifestyle ranges from $700-$1000/mo. Thailand has essentially no pension-like system at that low dollar amount and the WSJ contends that most people have no savings either. The default assumption seems to be that old people will move in with and be cared for by their children. The few people profiled as caregivers in this context are in their 50's/60's and they are portrayed as themselves being physically worn out. 

I don't know how you make a $35 payment (if accurate) work in the context of a $700 lifestyle but this example sheds a little light that maybe things don't have to be as universally dire in the US even if things are plenty challenging here. I'm not in denial about the US' retirement challenges, more like ok, this is the situation, what can we do about it.

A couple grossing $50,000/yr (current median is $65,000) where just one spouse works is taking home $3550/mo. If the one earner retires in 2030 at age 67 still making $50,000, his Social Security would be $1602 in today's dollars and the spousal benefit would be $801 for a total of $2403 so they are short of their working take home pay by $1147/mo. A positive for this situation would be they own a house and their mortgage will be paid at age 67 or sooner. There is the potential for their Medicare premiums to be less than regular health insurance but there some moving parts to that part of the equation. If the mortgage is not paid off, then yes something will have to give, probably some sort of part time work to make up the gap. 

The other WSJ article looked at Supersizing Your Retirement Account including contribute the max $70,000 to your 401k (for self employed) and a couple of others that seem financially out of reach for most people. The comments went pretty hard after the $70,000 idea. 

As opposed to taking the advice about putting $70,000 away as the only idea, I took the context of the article to be focused on people about 50 with little saved but making pretty good incomes, not killing it. If that is their situation, what can they do about it?

I think a plausible scenario at 50 is a house that had a 15 year mortgage now being free an clear, kids up and out successfully and diverting what has been the mortgage payment into retirement savings. If this worked out to be $25,000/yr, after 20 years of compounding at 7% (not a heroic assumption) they'd have just over $1 million when they are 70. Yes, maybe they don't want to work that long but at 50 with very little saved, something might have to give, will probably have to give. 

The backtest considers three different broad, multi-asset funds; GMO Benchmark Free (GBMFX), Permanent Portfolio (PRPFX) and Vanguard Balanced Index (VBIAX). Starting 20 years ago with $2000, putting $2070 per month in and you can see the totals as of today.

If this couple had accumulated $100,000 by the time they were 50 and started on this $2070/mo plan, putting it all into GBMFX would now be worth $1,313.000, PRPFX would be at $1,753,000 and VBIAX would have grown to $1,850,000. A quick note, when I played around with different timeframes, GBMFX compounded much closer to the other two.

The big takeaway is simple. Assess your situation and then figure out what you can do. You can't save $70,000 in one year? Ok, what can you do? 

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.