Did Your Alt Make The List?

John Authors had a little fun riffing on The Who saying he hopes he dies before the ten year treasury hits 7%. Plenty of pundits have been saying that treasuries with duration are now more attractive with yields in the fives. 

JELH is a lower yielding autocallable ETF, BKLN is a bank loan (floating rate) fund and UTEN tracks ten year treasuries. The negative return of UTEN is not thing to focus on. If you want to buy ten year treasuries here you must think they won't implode from here so the decline looking back is meaningless but the volatility characteristics probably will endure. 

If you think 5.2% is adequate compensation for ten years and buy UTEN (in real life buy a treasury not a treasury fund) then I would think of it as one small slice of the non-equity allocation. Treat it like any other alternative. Clients own BKLN which has its own risks but it is a narrow slice. Clients own merger arb as a fixed income substitute which has its own risks but it is a narrow slice. If you want to own duration here (I do not), keep it as a small slice in case buying at 5.20% turns out to be a terrible entry point. That's not a prediction, it's a matter of risk management. 

Speaking of the non-equity allocation, RCM has a whitepaper out that screened 12,000 funds looking for funds that beat the S&P 500 with lower volatility and a beta of less than 0.5. Only 22 funds fit that bill. It's probably not ok to list all the funds but several funds that we talk about regularly made the cut and I think it's ok to mention those. Obviously you can click the link, give RCM your info and get the paper. 

There are some narrow funds like Invesco Agriculture (DBA), several AQR funds including managed futures and QSPIX, BLNDX, Vanguard Market Neutral (VMNIX) and one we just looked at for the first time, the Federated Hermes MDT Market Neutral Fund (QQMNX). Kind of surprising was that a couple of buffer funds made the list too. 

There are several funds I am unfamiliar with on the list so we can dig into a couple of those in subsequent posts. 

A last point on this, I had a call with one of the funds I own for clients today and the company is working on a new alternative fund that will start trading at the end of the year or early 2027. It will be easy to understand versus some other things that we look at and this anecdote speaks to the idea of more interesting funds coming. I am not aware of another fund that does what this fund will do. Obviously, I am keeping the details confidential for now. We can circle back when/if it hits.

And one last item that is completely unrelated, the latest Social Security COLA was announced today at 3.6%. I think it is useful to keep tabs on this and get your annual statement if you are not taking SS yet and obviously if you are, you can do the math on your new payment in order to understand how close the COLA actually helps with your personal inflation index. Where COLA tracks a version of CPI, whatever is going on with healthcare costs is probably not reflected in the SS COLA, ditto with homeowners insurance.

I opened my current SS statement and applied the 3.6% bump to my age 67 and age 70 just to get a sense of the new numbers and on there of course was my age 62 number which before the COLA was $2725 and I had a thought that probably isn't rational which is ok, but I thought, "man, that really isn't much money." Maybe it's the two handle or I don't know what but I feel like I would be selling myself short settling for that amount if my career was ending. I realize more people lean toward taking it early, I'm not trying to convince anyone to wait, just sharing an observation. If there is some hideous benefit cut in 2032 that is far worse than any of the current working assumptions, of course that will just be something I have to live with but choosing that, man, I can't do 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.

Still Just An ETF In A CAGE

On Monday, I sat in on a webinar for the Calamos Autocallable Income Fund (CAIE). We've spent some time here trying to understand the risks to the fund. We had a small breakthrough recently, the fund is exposed to equity risk not the typical risks associated with fixed income like credit or interest rate risk. 

One of the things we've been trying to figure out is what should be the expectation if the market goes down sort of a lot but doesn't come close to the barrier (the point at which distributions are suspended). I asked in webinar, I asked about a 20-25% drop in the reference index. To the webinar's credit, the answer was very direct. If the reference index fell that much, we should expect the fund to fall by the same or similar amount. The distributions should still flow but the price would drop. 

With covered call funds there is often talk that they will go down less than the market cap weighted equivalent and that happens sometimes.....not always, maybe not even half the time but it can happen. CAIE appears to have less chance of going down less. 

This is probably the only example to look at since CAIE listed in June of last year. 

Another fund in the Calamos Autocallable suite came up that I've heard of but we've never looked at. You can tell from the name that the Calamos Autocallable Growth ETF (CAGE) is different than CAIE, it is growth, not income. A simplistic explanation is that it reinvests the coupon payments back into the NAV instead of distributing them as income. 

It is leveraged exposure, CAIE is actually leveraged exposure too. CAGE appears to be doing what it is supposed to do. There are some serious complexities to this that I don't yet have dialed in. If the reference index drops a lot, I would expect CAGE to drop more. 

Below are the questions I came up with that I fed into Gemini to start learning about the fund. The answers are long winded of course so I shortened them up make for an easier blog post to read.

Roger: Does CAGE solve the issue of volatility drag versus a fund like SSO? I realize the leverage is different.

Gemini: Yes but it imposes a 6% annual "decrement drag," a hurdle that must be cleared before the fund starts to go up.

In the conversation, Gemini asked if I wanted to see a 20 year simulation. Here's that output. 

Simulation Highlights & Trigger Frequency

Data from the historical simulations shows exactly how frequently the internal ~29%–30% compounding coupons trigger: [1, 2]

• Coupon Trigger Rate: Out of 2,537 simulated weeks, the index successfully triggered an early autocall or coupon capture 1,984 times. [1]
• Probability of Capture: This yields a 78.2% historical probability that a note within the fund hit its positive performance target on an annual observation date. [1]
• Annualized Performance: Over a rolling 10-year simulation window, the underlying index achieved a 23.75% annualized return, noticeably outpacing the standard S&P 500 total return index over the same backtested period. [1, 2]
• Capture Ratios vs SPY: The index recorded an upside capture ratio of 1.06 and a downside capture ratio of 0.86. It captured more market upside while blunting a portion of major drops. [1]

This color was important;

Summary of the Catch

The 23.75% simulated return looks highly attractive, but it is a byproduct of a 35% constant volatility target. During quiet, flat, or slowly grinding bull markets, the index uses internal swap leverage (up to 500% gross exposure to S&P 500 futures) to manufacture that 35% volatility. This synthetic leverage is what allows it to generate massive 30% coupons even when the actual S&P 500 is only up 2% or 3%. [1, 2, 3, 4, 5]

The risk is that in an extended, multi-year flat market, the 6% annual decrement drag will continually erode the index baseline, making it progressively harder for the oldest notes in the ladder to trigger. [1]

Roger: In a repeat of 2000-2009 inclusive, should the fund be expected to do worse than simple market cap weighted S&P 500?

Gemini: Yes, CAGE would be expected to perform significantly worse than a simple market-cap-weighted S&P 500 during a repeat of the 2000–2009 "Lost Decade."

Roger: Is the 6% hurdle how JP Morgan gets paid?

Gemini: Not exactly, more like how it can pay out the huge "coupons" that get reinvested (simplistic term for the circumstance).

Roger: Would it make sense to buy the fund after a large decline in markets and all those problems start happening?

Gemini: Yes.

Roger: SSO tends to track 2x the S&P 500 closely over longer periods. Again, just a tendency. CAGE seems like it would have greater variation in how it tracks the S&P 500. Is that correct?

Gemini: Yes

This next point is very important.

The Dynamic Leverage Shifts (35% Vol Target)

• SSO maintains a rigid 200% exposure to the S&P 500 every single day, regardless of whether the market is calm or chaotic.
• CAGE dynamically adjusts its leverage to maintain a constant 35% implied volatility target.
  • In a quiet market (low VIX): CAGE must heavily lever up (sometimes up to 400% or 500% gross exposure) to manufacture that 35% volatility.
  • In a wild market (high VIX): CAGE must drastically de-lever to keep its internal volatility from spiking past 35%.
    This means CAGE's effective beta is constantly morphing based on market fear, causing huge tracking variations over time.

Not because it is easy to understand, it isn't, but it speaks to the complexity of the fund. I later asked if it is constantly adjusting the leverage and the answer was yes. That also applies to CAIE, it is constantly managing the leverage to dial in the correct volatility target. This could lead to a whipsaw of sorts although that hasn't happened up to this point. 

Roger: Could CAGE be thought of a way to allocate to asymmetry but without diversifying the risk away from market cap weighting?

Gemini: Yes (it liked that framing).

Hoo boy, that is a doozy of an introduction. I tried to make this a simplistic introduction not technical paper. Please leave a comment if you dig in and find things I missed in this first look. 

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 Six Month Wait?

Cards on the table, I haven't been to the doctor for a physical in a few years. I never liked my old doctor and my interactions with him had been deteriorating for a few visits. His response to "I am not going to take a statin, I am betting my life that the cholesterol hypothesis is wrong" made the agenda that many/most doctors have crystal clear. I don't assume anything nefarious, just fear of being sued if they go off script. 

That is what I thought about in real time during the last cholesterol conversation, it was like Spinal Tap.

Regarding cholesterol, there are mountains of research showing that nominally high cholesterol is not the problem. Instead it is sugary/carby diets that cause the cholesterol to gunk up which results in clogging us up. I first clued into this in 2004 when I read something that concluded statins don't prevent a first heart attack. I'm not trying to convince anyone of anything here, I have invested tons of time, advocating for myself, and this is the conclusion I draw for myself. To be clear though, it is factual that research on this has been done if you are curious enough to seek it out.

I turned 60 a few months ago and I need to start up getting physicals. Prescott has shockingly few doctors, I knew this would be close to impossible in Prescott but, we're down in Tucson quite a bit, it shouldn't take too long. Wrong. The first appointment I could get was March 11th. 

The system is broken. Six months is absurd. No wonder people get sick and die. So I did something kind of crazy on Wednesday of this week. I signed up for Amazon One Medical, had a Zoom consultation with a doctor on Friday and am going for bloodwork on Monday afternoon. I will then have a follow up with the doctor in a couple of weeks. So the doc I met is listed through Amazon, which is like Teledoc I suppose. The Amazon One Medical program seems like a sort of concierge service that costs $99/yr and I can add my wife for $66. The $99 (or $165) allows for quicker or maybe better to say more convenient access to some very simple things. 

Part of my willingness to go this route is that I don't have a lot of faith in the healthcare system's ability to treat chronic maladies as opposed to acute problems. So the doctor doesn't need to be great. The system seeks to manage chronic conditions with medications that require taking other medications to manage the side effects of the first medication even though for some conditions, the answer could be to just eat less sugar. Two fire trainings ago, I asked one of the firefighters to look up and read out the side effects of Jardiance and of course they sounded awful. I then said to the group "or...or...or you could just eat less sugar." Then at the next training I asked another firefighter to look up and read out the side effects of Zepbound which were similarly awful. Or...or...or you could just eat less sugar.

I don't know if my doctor is any good but reading tests results and using AI (I just assume doctors use AI, younger doctors anyway) is manageable even for a so-so doc. God-willing there's nothing wrong, I can dance the cholesterol tango with this guy and be done. 

The prompt for this post is an article from the NY Times about exercise helping cancer patients better endure treatment and reducing the incidence of recurrences of illness. If that gets people to exercise, that's great but vigorous exercise can play a crucial role in preventing cancers and other illnesses. Of course I bang the drum constantly about lifting weights. Go follow PD Mangan on X to learn about the various metabolic processes triggered by weightlifting that greatly reduce the odds of getting sick.

I am big on the idea that it is up to us to prevent/solve our own problems. That sentiment is about inputs, not outputs. You can exercise, eat well and generally do the right things and still get sick but odds for avoiding illness improve dramatically by having a flat stomach and building and then maintaining muscle mass/strength. This doesn't mean being jacked like an action figure, just lean with some muscle/strength. 

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.

Can You Actually Live Outside The Box?

Barron's had a long article about how difficult it has become to diversify a portfolio because of the dominance of mega cap AI and semiconductor companies in indexes like the S&P 500. The article goes on to make suggestions about factors and equal weighting for equities. You could "fix your fixed income" with CDs, treasury bills and money market funds.

Included toward the end of the article was the suggestion to think outside the box by adding a little gold or commodity exposure. 

Not a whole lot of unique ideas there. We build some extreme ideas here to try to help think about how things that really are outside the box could fit in to actually solve a problem a little better than just buying a CD.

I like the idea of barbelling. We've applied this in different ways. The idea I am trying to convey in that picture is a little bit in yield, a little bit in growth and a bunch in exposures/strategies that should compound a little better than T-bills, offer some defensive attributes or maybe both.

The first four names are the yield, the next two are the growth and the rest are the absolute and alts. most of the names are one we use regularly for blogging purposes except maybe Cambria Shareholder Yield (SYLD) as part of the growth allocation. We're not totally selling out for a 15% yield in that sleeve, there's some diversity of risks in that group. For equities, SYLD and IMTM are underweight AI and semiconductors. I chose SYLD because of the manner in which its results differentiate from market cap weighting. SYLD has had years of misery and glory on the way to not great long term results so we're not cherry picking something great. 

There's not much variation from year to year for the 20/60/20 portfolio we're working with today which is good.

But the bar chart sets an expectation that it will lag VBAIX in most individual years. There's plenty of different types of exposures, the mix is legitimately diversified but that doesn't mean actually implementing this sort of concept would be easy to endure. 

Even Claude liked the idea and Claude hates everything. Copilot is a bit of pushover so I went with Claude. The clearest suggested improvement was;

Thinking outside the box requires being willing to actually live outside the box. Experience tells me that is more difficult for people than it sounds. 

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.

Harsh But True

Some odds and ends today.

Chances are you know not to get a reverse mortgage other than as an act of desperation but you know someone who is not clued into this. I learned about someone in Walker who is underwater on their reverse mortgage because of how long they took it out and now they want to sell to leave Walker as a function of age. 

Technically, you can't be underwater on a reverse mortgage but as you take payment after payment each month your balance builds up and when you sell, that balance needs to be repaid plus the interest. If the balance and interest exceed the value of the sale proceeds you get nothing. The lender gets made whole by the FHA.

I don't know these peoples' financial situation but getting money out of their house won't be a part of it. 

Allan Roth wrote favorably about TIPS ladders. I'm not a fan but he is. I should say I am not a fan of going heavy. We looked at a use case of a small allocation for an expense that might track somewhat close to CPI versus expenses that won't. Property tax yes, various types of insurance no. 

If the intent is insulating a piece of money against inflation without taking on full stock market volatility, ok, they should be better than bonds but I think there are better ways to do it without the volatility of long dated TIPS. 

Finominal did an assessment on this model portfolio from JP Morgan.

It aligns as 75% equities and 25% bonds. Finominal thinks the best comparison is 75% iShares Russell 3000 (IWV) and 25% IUSB. 

I loaded this into testfol.io but replaced JBND with BND which is a Vanguard fund that does the same thing and allows us to look at four years.

Um,

This is a recurring theme with a lot of model portfolios. No differentiation. I had a blog post a few months ago titled something to the effect, why use two funds when you can use 11 which are the numbers in today's examples. 

I think JP Morgan is just showing how their funds can be used which is fair but I don't know why any advisor would implement this. 

Barron's wrote about what to do now that "interests rates are surging." Whatever happens next, it's a bad bet to think you can out nimble the interest rate market versus laying out a plan for yourself ahead of time and generally sticking with it. 

We have framed this as recognition that rates weren't compensating the volatility and risk of longer dated bonds. We spent a lot of time trying to build a portfolio sleeve that would do what people want bonds to do and added the consideration for what point yields will adequately compensate for volatility and risk of longer dated bonds. 

Several of the recommended funds in the article are low duration. Is now the time the rotate from long duration to short duration? Where were they five years ago? Making that trade now is a guess that might be correct or maybe not but reacting after the surge is not assessing the risks it's a guess. Harsh but I think correct.

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.

Interesting ETF Filing

The newly filed for Brinsmere Balanced Fund (proposed symbol TBFB) is going to do a variation of the portfolios we theorize with here. The very short version is 20% in equities, 20% in bonds and then sort of a go anywhere with the rest which "may include gold, commodities, and managed-futures" but it will seek to have similar returns to a traditional 60/40 portfolio. 

Brinsmere has a proprietary process for selecting what gets included in the fund and although I did not see anything in the prospectus about trying to reduce volatility (corroborated with Grok) it is plausible that lower volatility would be part of the outcome, and even if that is incorrect, we can play around with their idea in pursuit of that outcome.  

Using the following to get a decently long backtest;

The volatility looks great while the growth rate lags behind a little. The way it backtests looks like it achieved 75/50.

The period studied includes a stretch where both managed futures and gold floundered for several years and of course 20% in all world equities creates a drag versus 60% in domestic-only equities. Shortening the backtest up to six years was far more favorable, the growth rate of the mimicked portfolio was slightly ahead of VBAIX and the volatility was about the same 6% or so. 

If we consider a much shorter period, we'd have many more ways to fill the 60% bucket for a more robust mix including cat bonds that we use frequently here and that are in client accounts. I used XYLD which is an old covered call fund as sort of a proxy for a buffer fund. XYLD has no shot of keeping up with plain vanilla equities on a price basis. On a price basis, XYLD has compounded negatively ever so slightly in the period studied versus a CAGR of 13.92% for the S&P 500. QSPIX is not my favorite for any strategy but it is useful here for having a long track record. Like several other AQR funds, it seems prone to occasional long periods of lagging, 2018 through 2020 was dismal.

ETFs can't own mutual funds but something MKTN that we looked at the other day could slot in for QSPIX, ILS is an ETF that owns cat bonds and there are several merger arb ETFs.

Good luck to the Brinsmere guys, I hope the fund lists and is as interesting as our mimicking of their idea. 

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.

Woefully Flawed Backtesting

 Hopefully this will be obvious.

Any sort of long term study involving Bitcoin is built on a growth rate that can't be repeated. Over the last ten years, Yahoo Finance has Bitcoin is up 32,000%. That unrepeatable gain is built into the impact cited of 1% added to the portfolio.

It has been awhile since we included Bitcoin in one of our studies but I typically didn't go back further than 2021, where I have the yellow line because of the unrepeatable nature of the some of the earlier returns. 

Backtesting is useful but not infallible. I try to point out flaws that I see in some of the backtests we do but this one with Bitcoin is especially easy to observe. 

A quick follow up to yesterday when we looked at the MKTN ETF which hasn't been around that long. It turns out there is a mutual fund version with the Federated Hermes MDT Market Neutral Fund (QQMNX). Hat tip to reader Max for finding this fund. For some reason, Testfol.io only goes back about five years with that fund but it is quite a bit older. Portfoliovisualizer lets you go further back.

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.