Broken Benchmarks

Here's a doozy. Nicolai Tangen who is the head of Norway's sovereign wealth fund is very concerned about the economic fallout from the war in Iran. He's modeling in a 49% decline for the fund's equity sleeve and a 37% decline for the fund overall. That doesn't appear to be a prediction, it appears to be one possible outcome out of many from an analysis they ran. 

Here's an even bigger doozy from Ted Seides who says the S&P 500 is broken as a benchmark due to concentration issues primarily, but that the concentration causes other problems that skew passive versus active investing. Something is just off because of how badly passive is beating active, it doesn't make sense in terms of magnitude or persistence he said. 

He notes single stock volatility is pretty much at all time highs which helps the largest tech companies dominating the index. He also said there is more chop at the sector level too. The 44% in tech plus communications should cause us to "rethink what that means for portfolio construction and performance measurement."

We've talked before about the tech sector tending to outperform the broader index in both directions most of the time. If the S&P 500 is broken because too much is in tech and communications and too much is in just ten companies then that causes all sorts of problem with portfolio performance measures for larger pools of capital like mutual funds and hedge funds. At some weighting to tech  stocks you've got these types of vehicles benchmarking to the tech sector not a diversified index. Ted's context included the extent to which the industry is entrenched deriving alpha versus the S&P 500, the index is used for beta and although not part of the formulas for Sharpe Ratio and Standard Deviation, the index is the comparison. 

"Equity market exposure should provide broad-based, diversified, liquid exposure to economic growth. Today’s S&P 500 ignores most sectors in the economy, while favoring sectors that have been winning and are highly exposed to the future of AI." 

"In today’s equity markets, diversification no longer resides in the cap-weighted S&P 500."

This is less of an issue for advisors. If a portfolio is doing what the client needs in terms of risk/volatility tolerances, kicking off a sustainable income if needed and capturing growth then that is what matters. So from that perspective, benchmarking an advisory client to the S&P 500 is fine. My clients have nowhere near 44% in tech and communications, that is a lot of potential risk that is easily avoided. There's no way to know if there will ever be a consequence for that risk but the risk is there all the same.

If something terrible happens to the broad index, it seems pretty logical to think it will be tech plus communications that will take the worst of it because that is often how it goes but a little more bottom up, there are plenty of signs of current excess with those two sectors. 

You've probably heard of the the Invesco S&P 500 Equal Weight ETF (RSP) which as the name implies equal weights all 500 constituents of the index so Nvdia has the same weight as Organon. Less talked about though is the ALPS Equal Sector Weight ETF (EQL). I wrote about this fund when it first came out in 2009 for theStreet.com.

According to my article in 2009, tech's weighting (which included communications back then) in the S&P 500 was 18% versus 44% for those two now. RSP now has a combined 17.1% in those sectors. After rebalancing, EQLs weight to the two is 18.18%. The chart shows differentiation between RSP and EQL versus the S&P 500 and I threw in SCHD which only has 13.5% in tech plus communications. You can see they started out similar but then VOO pulled away as tech started to outperform at an accelerating rate. If tech continues to rip then yeah, RSP, EQL and SCHD will fall further behind but if the idea is not wanting to be front and center to a tech implosion while still using broad based index funds, these should be looked at. 

Strategically, I think this is where capital efficiency in terms of leveraging down could come into play. This space is evolving. Quite a few providers offer funds that leverage up like the ReturnStacked Funds which tend to be 100/100, WisdomTree has several that are 90/60 along with a couple of others that are 90/90, Simplify has a couple, Unlimited has a couple that target twice the volatility, and there are some one offs out there where I bet the providers will increase their offerings. 

The latest one that came out this week is the WisdomTree Efficient US Plus International Equity Fund (NTSD) which is 90% domestic and 60% foreign. For an equity allocation, a 67% allocation to NTSD with 33% in cash could equal 100% of an unleveraged equity allocation with no cash leftover. There might be a slight performance dispersion one way or another but whatever happened to equities, 33% would be sitting there in cash. If the 60 domestic /40 foreign equity sleeve fell 30% then you'd expect NTSD to fall 45%. With 33% in cash, the dollar consequence would be the same but the cash would just be sitting there. 

That strategy wouldn't address the index concentration issue but for a $100,000 equity allocation, there'd only be $67,000 exposed to risk assets. 

We've looked at examples likes this before. With just about every 2X fund, the dispersion between the index a two times the index in a fund is very wide but SSO has been pretty true to capturing twice the S&P 500. As the capital efficient space evolves, this concept might actually make sense to 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. 

Cross Asset Dislocation

The way the current market event is playing out, most higher volatility diversifiers are not doing well. The most curious case is gold. The other day we talked about gold maybe having priced in something bad happening in markets as it ran higher at the start of the year. In late January a few of the accounts I manage for other advisors had grown to more than 10% in gold, the previous manager believed in a higher allocation than I do, so I reduced their exposure. It's really a big deal to size things appropriately. At some weighting gold goes from being a diversifier to being a source of unwanted volatility. 

Gold's decline is odd to me. The price of energy going up makes it more expensive to pull gold out of the ground. That makes sense and sounds like a negative factor for the miners, the miners dropping makes sense. But this concern would seem to put downward pressure on new supply coming online so gold getting clocked seems like some sort of dislocation. It happens.

Client/personal holding BTAL has not been doing well for the last week or so as we mentioned the other day. Tech already dropped a fair bit coming into this and so since the war started its been down less, XLK is about 200 basis points better this month than the S&P 500. 

Foreign equities getting clocked. Miners getting clocked after a fantastic run, I mentioned shaving that exposure down a little bit earlier in the year, it's important to size things correctly repeated for emphasis. Managed futures is limping along, as we said the other day we're still inside the initial 10% decline where manage futures doesn't necessarily kick in but I don't think it's the poster child for the markets' struggles like maybe gold is or bonds with duration which have been dropping in price over inflation concerns. Inflation concerns are another reason why you might expect gold to be doing well. 

Things that have been working are the holdings that should look like a horizontal line that tilts upward. Anything with energy market exposure is probably up but of course holding on to those parts of the market is very difficult for the volatility the 99.9% of the time we're not in a war that threatens the energy markets. Also, straight inverse funds are working correctly. 

No diversifier can work in every single adverse market event which reiterates the idea of having correct sizing of not just alternatives but everything. You don't want to find out you had too much exposure to equities after a large decline. Some diversifiers will work and some won't in a particular event. Maybe all will work in another event. Either way, diversify your diversifiers. 

Gold is down low double digits. Will it keep going down? Who knows but if you have a 20% weighting you might be really sweating this decline. Get the sizing right.

Here are four all-weatherish funds that we talk about with varying degrees of regularity. AOR is a 60/40 fund. ALLW is a Bridgewater strategy. PRPFX is the Permanent Portfolio. Trinity is heavy on trend. And BLNDX is a long time client and personal holding. The chart doesn't capture PRPFX dropping 119 basis points on Wednesday or BLNDX' drop of just 19 basis points. TRTY and PRPFX are both doing better than I would have expected but they're not impervious to the broad decline. That speaks to the challenges that the war is posing to markets. 

I forget where I first heard this but the idea with what we talk about in terms of defense, using alts and avoiding the full brunt of large declines is that we are trying to chop off the left tail, the large and negative outlying return. Right here, we're in about a 6% drawdown which is not a large and negative outlying returns. If you use any sort of defensive or diversifying strategy, if the market continues to decline then I would expect to get a type of convexity effect like maybe gold will figure it out, maybe more trends fall into place instead of the recent chop which would help managed futures and so on.

Whatever this event becomes, it will eventually end and then the market will start to work its way higher, eventually making a new high. The only variable will be how long that all takes. 

And a quick follow up, Bloomberg is reporting that S&P lowered its outlook on Cliffwater Corporate Lending Fund (CCLFX) to negative based on concerns about redemption demand.

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. 

C'mon Gen-X, You Still Have Time To Rally

In more than a couple of instances, I have titled blog posts C'mon Gen-X, Time To Rally about my generational cohort having trouble getting to where they need to be in order to retire without making enormous sacrifices. I would count not actually being able to retire as an enormous sacrifice as well as not being able to spend money on anything but the most basic of needs; food, shelter and healthcare.

The prompt for this post was a quick look, really not a review, just a cursory look at a book called Retirement Bites which is a play on words for the Gen-X anthem-ish movie Reality Bites. As an older Gen-Xer I'd say that Breakfast Club or to a lesser extent Pretty In Pink defined our cohort. The book is written by Kerry Hannon from Yahoo Finance. Here's a gift link that has more about the book.

Hannon and her coauthor Janna Herron believe in needing to figure any psychological hangups people have with money like growing up with very little money or any other sort of financial trauma. I'm not huge on this but I might have a bias here. My parents were terrible with their money and it was easy for me to recognize as a kid how difficult they made things for themselves. I've described this before as benefitting from their mistakes. 

All aspects of retirement should be long term focused. If you have been accumulating money along the way, hopefully you started at a youngish age. As you approach 50, still a long way from retirement, hopefully you make some effort to understand what sort of numbers you will need with more depth than just saying 80% of your income or some other vague rule of thumb. 

Social Security also lends itself to long term planning. Here's the latest from Bloomberg that points to benefits being reduced as soon as 2032. The thinking is still cuts to payouts just under 25% which is not a new number and while it sounds big, anyone paying attention has known about this for years and still has quite a few years to go to figure out how to mitigate the impact. I still don't think there will be a cliff for people above a certain age but I see less commentary/theory agreeing with my assessment. 

Social Security wants us to know how much we're getting in today's dollars, so then just lop off 1/4 to know what you're likely to get. At 50 or 60, you have plenty of time to digest the numbers and plan accordingly. 

There is wide agreement that Social Security, reduced or not, is not intended to be sufficient for most people but it can be significant. A $3000 payout as part of an $8000 lifestyle is significant. We talk all the time about figuring out how to monetize something like a hobby or a volunteer gig. This also needs to be a long term process to create, or at least odds of success go up playing the long game with this. 

Sticking with the $8000 lifestyle example, bringing in $2000, $3000 or $4000 from a monetized hobby or volunteer gig turned paid gig would again not be sufficient but would be significant. 

Bloomberg also talked about retiring to another country, focusing on France, Costa Rica, Spain, Italy and Panama for this article. One of the comments on the WaPo link for the book review glance said he rents his house out in California and lives in Central America. That is exactly what we've talked about here. There are plenty of places where Social Security plus rental income from a mortgage free house back in the states will be sufficient in case the retirement account is more of an emergency fund. 

We've talked countless times about keeping the house in the US in case you need or want to come back or get out of where you moved even if just temporarily. We last looked at Ecuador in this context  but the war in the middle east is another example. This article from the WSJ creates the impression that Dubai was believed to be impervious to any sort of mid east conflict. It seems like an easy risk to mitigate, something going really bad in whatever country you chose and having an easy option to come back. 

What about continuing to work? Plenty of people are desperate to stop working while others never want to retire. Continuing to work can go in several directions like scaling down hours and then sticking with it for a while or maybe delaying retirement by two or three years to build up account balances, reduce (even if just slightly) the number of years that the money needs to last or in some cases literally never retiring as a matter of choice. 

In the meantime though, the way the Retirement Bites authors describe it, Gen-X is in a lot of trouble. At 50 or 55 or 60, someone making a decent income but that just never got around to saving money due to life circumstances could plausibly find themselves mortgage free, kids up and out and now able to start saving. That is not too late to build up a bit of a retirement fund. At 60, with no retirement savings, only a generous pension would spare that person from having to work a good bit longer but 10 or 15 years is enough time to build up a piece of money that would generate a significant income in the context of our $8000 example above. 

I'll close out by paraphrasing Joe Moglia, no one will care more about your outcome than you so c'mon Gen-X, you still have time to rally. 

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's Not Catastrophic, It's Just Not All-Weather

A while back we stumbled into an interesting blend of fixed income ETF with 50% in iShares MBS ETF (MBB) and 50%,

Backtesting to RISR's inception, it struggled a little in 2022 when the treasury market was blowing up but that was nothing compared to TLT and for the most part it has looked like T-bills. It's interesting that the price only return is almost the same as T-bills.

I asked Copilot what the story is here. It looks kind of bullet proof. I realize it's not but I want to understand the risk. MBB and RISR have been negatively correlated, almost perfectly so, which is why the blend looks like that. 

Copilot said that the negative correlation would flip positive if mortgage spreads widened dramatically, citing 2008 and 2020 examples with late 2022 as being modestly negative for the blend. Copilot theorized that in 2008 it would have been down 9-10% and in 2020 it would have been down about 8%. In 2022, there were two negative months in a row adding up to a little less than a 4% decline. 

I pushed back that "The arguments you're making seem to say it won't do very well when there is absolute calamity but even then the results aren't catastrophic. They're just not that resilient." 

"A 50% RISR / 50% MBB portfolio is not a ticking time bomb. It’s not going to implode, it’s not going to behave like high‑yield credit, and it’s not going to deliver catastrophic drawdowns even in severe stress." Then it said "it's not catastrophic, it's just not all weather." 

It's "not even particularly bad in the context of fixed income" which literally made me laugh out loud. The original response made it sound this idea was more risky with more volatility than ZROZ which is like trying to hold onto an M80.

MBB/RISR doesn't take interest rate risk but the spread risk would be unique versus the other things we talk about. Whenever the next cataclysm happens, the blend we are talking about today might feel it a little more but the rest of the time, it might look like how it's performed since we started tracking it. 

The information, analysis and opinions expressed herein reflect our judgment and opinions as of the date of writing and are subject to change at any time without notice. They are not intended to constitute legal, tax, securities or investment advice or a recommended course of action in any given situation. 

When Diversified Isn't Diversified

Torsten Slok's Saturday email included the following chart and he said the index' concentration is moving toward 50% in the top ten if/when Anthropic and SpaceX go public.

He said the "S&P 500 basically doesn’t offer much diversification anymore."

Here's a fascinating quote from Jeff Currie at Carlyle, he said "in the 1970s, energy at 25% provided a natural portfolio hedge. At 3%, that hedge has vanished."

Mike Zaccardi Tweeted out this chart.

I think I randomly noticed the duration getting a little longer at some point but I don't really keep tabs on this the way I do for S&P 500 index composition. 

The Oregon Public Employees Retirement Fund has had its hat handed to it for getting lousy returns from its 26.5% allocation to private equity. "They appear to be after the highest-returning asset without respect to risk-return considerations and without regard to their seeming lack of selection skill." CIO Rex Kim is cited as calling the criticism myopic, the fund is focused on the long term. That would be ok except for the various budget cuts, one small school system had to make serious cuts to staff, occurring now not in the long term. 

The tie in for all of this is how to embed robustness or resiliency into an investment portfolio. Here's Bob Elliott from Unlimited Funds giving his thoughts on how important this is.

We obviously spend a lot of time here on how to do that. The balance is walking the line between kneecapping long term growth of the portfolio while not taking the full brunt of large declines or being a forced seller after a large decline to meet income needs. 

Obviously the belief here of how to best do this is to combine small weightings to esoteric fixed income niches and alternative strategies with differing attributes. 

In the past, we've frequently said putting it all in an equity index fund is valid but not optimal. Currie's observation about no built in hedge speaks to part of this, another part is the occasional enormous declines that might reasonably induce a panic sale at exactly the wrong time. The right combo of robustness and resiliency can prevent ever being in a position of potentially panicking. 

The anecdotes about AGG and OPERS are different manifestations of the same issue, not having a great understanding of how risk works. Also with OPERS, if there really are budget cuts now because "long term" investments are doing poorly, then the investment team has mismatched its assets versus its liabilities. 

Making portfolios more robust is not rocket science and it gets a little easier when you can accept that not every alternative strategy or esoteric fixed income niche will do well in every single adverse event. That is why you diversify your diversifiers. 

Don't make it 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.

It Just Has To Work

Barron's laid out a path to a stagflationary outcome like we had in the 1970's noting the dynamics of the oil market being the primary factor. The Friday growth revisions and inflation data didn't help to refute the argument. 

Bloomberg took up a similar conversation talking about what various investment firms are doing to help with the current equity volatility against a backdrop where plain vanilla 60/40 isn't really working.

There was a bit of a spaghetti thrown against the wall aspect to the different strategies expressed in the Bloomberg article. Bonds often work in times like this but are not for reasons we've gone over ad nauseum. What about gold? It sort of isn't working but I have a different take. Gold already worked. Arguably it priced in some sort of turmoil rising about 70% in the last year.

Are there some equities working? Yes but there are always some equities working no matter how bad it gets. For this event, defense stocks certainly have been working until the last week or so, rolling over a little. They also might have priced in turmoil ahead of time. 

There was no mention of managed futures which have been interesting in terms of the dispersion of performances. Over longer periods, performance dispersion seems more like magnitude but in the same direction. The long list of funds I track collectively seem to be doing different things on a daily basis. The differences probably come down to different types of signals used as well as risk weighting of positions. There have been times were managed futures has just been killed during equity market volatility, the first 10% down, but that isn't happening now. 

Another Bloomberg article suggested buffer/defined outcome funds instead of bonds to help with equity volatility. Buffer/defined outcome funds certainly are not malfunctioning through this, so that's good. I have no reason to think they would malfunction but the basic ones will not be proxies for equities when you want them to be. 

Inverse funds are mostly working. But client personal holding BTAL had a couple of disappointing days in there when the S&P 500 was down (good for BTAL) but software stocks had a bit of a recovery (bad for BTAL) that seemed to puzzle people but happened all the same. Going to heavy in inverse funds becomes counter productive at some weighting as too much of a drag. I'm not sure where that line is but mid single digits is not counter productive. 

REITs have been doing well which is a bit of a surprise with rates going up. REITs have tended to disappoint in times of turmoil more often than not and yieldy REITs tend to go down when people can better yields from bonds. 

The last (only?) time there really was stagflation, foreign equity markets outperformed the US. This was the case in the 2000's albeit with a different circumstance.

Foreign has had a bad week but a real stagflationary event would last more than a week or two and I would want foreign equity exposure in that instance. 

What all of this is about is diversifying your diversifiers. Forty percent in bonds, not working. Meb Faber has tweeted about how close 60/40 stocks/bonds is to 60/40 stocks/gold over long periods. Great but gold this month is not working. On the next event, maybe both will work and the things doing a little better now will do very poorly

There's no way to know when some random diversifier you believe in just will not get it done. It would be nice if gold was working this month but I don't want to put clients in a position where gold has to work just like anyone putting clients into 40% bonds is putting them into a position where bonds have to work and they aren't. 

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 An ETF For That?

YieldMax dialed it way down for its new US Stocks Target Double Distribution ETF (DDDD). Instead of yielding 50%, DDDD will target twice the distribution rate of the Schwab US Dividend Equity ETF (SCHD). SCHD yields about 3.5%. DDDD owns a slug of SCHD as well as quite a few of the individual stocks in SCHD. 

The fund will overlay option combos on SCHD as well as some of the holdings using call spreads, selling puts and a couple of other strategies occasionally. The boilerplate says the fund may return capital as part of its distributions. 

Copilot said that based on the current holdings, the dividends generated before any options are implemented should be 3.4-3.7%, in line with the fund. 

I'd be surprised if it had to return much capital to find the extra 3.5% yield. I suppose it might want to do that for some reason but I doubt it would have to. The extra drag then from the higher distribution versus SCHD would only be 87.5 basis points per calendar quarter. I can't imagine it would look like any of the crazy high yielders that move down and to the right on a price basis very swiftly only to then reverse split and then repeat the swift decline toward another reverse split.

We talk about using small allocations to the crazy high yielders in some sort of depletion or drawdown strategy. DDDD simply paying a little bit more should be plenty sustainable for anyone who would rather take yield out than sell from more of a total return approach. 

For all the talk about private equity/credit firms, it turns out there is a pretty narrow based ETF tracking the space. The Van Eck Alternative Asset Manager ETF (GPZ) only has about nine months under its belt but it appears to do a good job tracking the industry which lately means the price is down a lot.

That's not all the holding but it's most of them. Not captured in the screenshot is Blue Owl with a 3.28% weighting. There's no Goldman, Morgan Stanley or any of the other multiline financials that dominate funds like the following;

While I can't see ever wanting GPZ, there is probably useful information keeping tabs on it.

I'll close out with advice from Barron's about The Best Way To Trade A Volatile Stock Market which is that investors "should do as little as possible." Maybe put differently, do less. If you've been reading this blog for a while, hopefully you recognize the pattern of small tweaks when risk factors change, not necessarily as an emotional response. That's the objective anyway.

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.