How Diversification Is Supposed To Work

Let's start with this.

If inflation continues to run at about 3.5% then that implies a real return of 3.5% versus 4.56% real return for Vanguard Balanced Index Fund (VBAIX) since inception or 5.97% real return for the last ten years. The real return coming down to 3.5% might be disappointing but it's not catastrophic. Getting an extra 50 basis points with alts would be helpful if the other assumptions turn out to be correct. 

Coincidentally, Finominal's Monday research looked at diversifying with gold, managed futures and bonds.

The first thing I wondered is why not run the same test with all three in one portfolio?

The first four portfolios allocate 60% to the S&P 500. Splitting the 40 between gold, managed futures and bonds does what it should. Volatility and the max drawdown both drop some and the CAGR is neither the best of the lot nor the worst. This is simply the building block of understanding that there's no reliable way to guess which diversifier will work the best and that by diversifying your diversifiers you should get exactly what we got with this exercise. 

On a related note, Matthew Bartolini from StateStreet was on ETF IQ and he had some interesting things to say about portfolio construction. Eric Balchunas said that bond funds like AGG are not providing the type of diversification that they used to. Bartolini had some stats to validate Eric's point but nonetheless, bonds don't do it anymore, so what does StateStreet suggest?

He talked about replacing AGG-like exposure with derivative income funds, high yield and bank loans. 

This last backtest only covers five years, going back to when bonds became unreliable. The yield didn't adequately compensate for the risk and volatility long before five years ago but five years ago is when it started to matter. 

Kudos to Bartolini for thinking outside the box. 

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 Alt Less Traveled

We talk all the time about alternative strategies. I've cited my awareness/interest in the idea back to an article about Jack Meyer who used to run the Harvard Management Company, the endowment for the school. I think this might be the article, it talks some about Meyer's interest and belief in timberland as a diversifier. He talks about the opportunity to get a 7.5%-8% real return from timberland, there is the implication of getting that return but with a low correlation to domestic equities. 

The prompt for today's post is an in depth look at timber investing by Meketa. The Meketa paper is thorough in terms of providing education but there wasn't too much in the way of how to access timberland. Many years ago, I owned Plum Creek Timber (PCL) for clients. It was a fine hold but I'm not sure it really captured the effect. A stock (or REIT in this case) that trades in the market will have a tougher time delivering a differentiated return stream. Weyerhaeuser took over PCL in 2016. I sold it long before then, I may have sold it to make room for RYMFX in late 2007 but I am not sure. For the last ten years, WY has compounded slightly negatively which isn't necessarily a catastrophe for a diversifier except that it was down more than the S&P 500 in 2022. 

Neither Grok nor Gemini could find a dedicated timberland interval fund. That wrapper would work for timberland, that would be something worth learning about but I can't see using an interval fund for clients but I do spend a little time studying the space. Gemini pointed to the Harrison Street Real Assets Fund (VCCRX) which is an interval fund, despite having a symbol, it is not a mutual fund. The allocation is interesting;

Included in VCRRX is Harrison's own infrastructure ETF. To Harrison's credit, the ETF is differentiated from the S&P 500 but looks very similar to some of the other infrastructure funds.

Here's a long term look at VCRRX, the parent fund so to speak.

It's a horizontal line that tilts upward. From the literature, the fund consistently lags behind its benchmark for growth rate but with a fraction of the volatility. The result is very similar to client holding Merger Fund (MERIX) so I am not opposed to that but I'm not sure it makes sense to to endure the limited liquidity and the 2.2% expense ratio for that result. The fund is intended to be absolute return so it is pretty much doing what they have in mind but 50% MERIX/50% BOXX would have the same result for 1/3 the cost and with the advantage of daily liquidity. 

A different path to MERIX' result interests me, we can revisit this if they ever put this into a vehicle with daily liquidity. 

Closing out with a chart from Barry Ritholtz.

We've looked at these several times in the past for blogging purposes. The way we framed it, I think these stocks do a great job of being proxies for investing in private equity and private debt without the expense or limited liquidity. We looked at them when times were good, they mostly go up more than the broad market with more volatility and now things are going poorly and they are down more than the broad market with more volatility. I realize the broad market isn't actually down in any sort of meaningful way currently. 

At some point these will bottom and I'm sure go back up again but based on the volatility, owning any of them seems like it would be very difficult. A quick editorial note is that I don't know anything about Hamilton Lane, really nothing, and from what I've read about Blue Owl, that one might be in a more serious situation than the others. BX is the one we've looked at the most for blogging purposes. It is currently at $109, down from $199 in late 2024. I imagine it will get to $199 again at some point but the path back to $199 might go through some much lower number first. 

Like I said, these are difficult to own.

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.

RMD Hack

That is the Vixen 21 TD, "the sports car of motorhomes."

It looks like a cross between an EM 50 Urban Assault Vehicle (Stripes reference) and a DeLorean. No joke, one of the designers of the DeLorean was involved with the Vixen. It was fast for its time in the 80's. It was also designed to fit inside the typical garage at only 6'4" tall and 21 feet long. 

We talk frequently about optionality here. It is high up on my priority list and while a sporty number like the Vixen 21 TD having room for all your stuff and the kids might be a tortured analogy, I've had this search result open in a tab all week waiting for me to figure out how to work it into a blog post. 

The optionality we are talking about relates to RMDs. Anyone who is still working at their employer past RMD age does not have to take an RMD out of their 401k. If they are in that situation and have an IRA outside of their 401k, they do need to take the RMD. The 401k issue more complicated if you own more that 5% of the company so talk to an accountant. 

Even though the an employee is taking their RMD, they can still contribute to their 401k thus effectively offsetting their RMD up to the amount they can contribute. If someone's RMD is $38,000 and they contribute $20,000 to their 401k, then their "net" RMD would only be $18,000. They still need to make the full contribution and in a separate transaction take their RMD but the net effect is the same.

This can also apply to people who are self employed with a Solo 401k and have earned income. I've been thinking about this for my own circumstance. Some advisors never retire which is how I have been leaning. At this point, I don't know if I will have earned income during my first few RMD years but I might. 

If my early RMDs are somewhere between $30,000 and $60,000 and lets say I have $50,000 of earned income still, Gemini thinks I could contribute $41,000 to my solo 401k, offsetting some or all of my RMD. Again, these would have to be separate transactions, make the contribution and take the RMD. 

The tie in for optionality is relieving some of the burden from portfolio. This is what bridging as we've discussed it, does. The primary account, presumably a rollover IRA doesn't have to start generating an income at 65 or whatever age so instead of needing to do so for 30 years, maybe the bridge shortens it to 20 years when starting at 75 instead of 65. And maybe this lower or part time earned income for a couple of more years can shave two more years off that 20 year window which to my way of thinking preserves optionality for needing to maybe spend more on in home health or some sort of expensive medical treatment that insurance won't cover. 

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.

Good News For HSAs?

We'll get to HSAs in a minute but I wanted to start with Bloomberg saying that retirees are afraid to spend money on fun for fear of running out before they die. These articles are all over the place as far as no one can retire, people have too much money and everything in between. 

Shifting from accumulation to decumulation is difficult for plenty of people. It really is a psychological shift, of course some folks will have no trouble but for others it will be difficult. I assume I will tend toward the latter camp.

The article makes a quick reference to spending in buckets. My thought process has drifted in that direction for how my own older age finances might play out. The way the conversation on this has evolved here, my take on buckets is probably a little out of consensus, I think three buckets can suffice and maybe only two.

I think a sequence of return protection bucket that is cash with about two years of expenses is pretty important. Two years of expected expenses is about bear market resilience and not having to sell stocks after a large decline. Before the last few years, bear markets tended to last 18-30 months but it's been a while since one lasted that long. 

We've spent a lot of time on an intermediate term bridging or depletion bucket. The context for this idea is as a bridge to the next financial milestone like starting Social Security or taking IRA withdrawals, whether they are required or not yet required. In that light, maybe we're talking about an eight-ten year window. We've looked at building very yieldy portfolios designed to be spent down at a rate that would not be sustainable for a typically long retirement but with a reasonable shot of getting to the end of the eight-ten year bridge objective with a little left over. Starting with $400,000 for example, taking out $40,000-$45.000/yr for ten years and having $50,000-$60,000 leftover after ten years would be a big success with this.

Going into this idea thinking, "I know this piece of money will only last ten years" is psychologically far more palatable. There's no open end objective that goes with not knowing when retirement ends. Maybe this starts at 65, lasts for ten years to starting RMDs and if things go well, maybe there's another year or two's worth money still in the account. The RMDs would really be the start of decumulation, that first ten years might be decumulation with training wheels to get used to the idea. 

Quick pivot to another Bloomberg article about Dividend Nomads. These folks are branch of FIRE living on distributions from various types of funds. One of the people profiled is living off of distributions from $130,000 that was invested across several YieldMax funds including CONY which references Coinbase and went down a lot. Another profile focused on funds like JEPI which are certainly high yielding without being NAV incinerators like many of the YieldMax funds. A fund like JEPI yielding 8-10% would be a reasonable fit in the bridging strategy we talk about above. The third people profiled sort of didn't really belong in the article, they accumulated a lot of money and own a few 3% yielders which is a sound strategy but not terribly interesting. 

As I read the first two profiles, these people don't have a lot of money but they are making it work. This is a point I've been making back to the earliest days of the original blog site, I saw this often here in Walker. Neighbors without a lot of money were making their retirement work because they had to. 

Ok, HSA accounts. The WSJ had an article that was a refresher on how they work. Toward the end was this passage;

Expansions benefiting ACA users

In 2026, new provisions took effect that benefit individuals with ACA coverage. They enable HSAs to be paired with Bronze and Catastrophic plans, which have the highest deductibles.

This change is good news for several groups. One is self-employed workers. Another is early retirees who use ACA coverage and aren’t yet eligible for Medicare. Still another is the fairly small group who opt only for the ACA’s catastrophic coverage.

HSA eligible plans that make financial sense have been tough to find through the market place for several years. Gemini, does this this mean it should be more accessible? 

Yes, this rule change makes HSAs significantly more accessible if you are self-employed. Under the One Big Beautiful Bill Act (OBBBA) which took effect on January 1, 2026, federal guidelines fundamentally changed how marketplace insurance plans interact with Health Savings Accounts.

Hopefully Gemini is correct, we'll know next month. I think we've had an HSA eligible plan just one time in the last six or seven years. It would be nice to get four more years of contributions in before I hit Medicare in 2031.....actually we could get ten more years of HSA contributions. Assuming it ever makes sense again through the market place, we could have a family plan for four more years putting $10,000 into the HSA then for the six years my wife is not yet on Medicare after I start, she could have an individual plan, putting in $5400/yr for six years. 

The last couple of years we've had really crappy insurance and I am wondering if that might not be such a great idea now that I'm 60. We had help from an insurance broker for the last couple of years so maybe he can help us find and HSA, I'll report back next month. 

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.

Is Low Dividend Yield A Harbinger Of Doom?

Barron's looked at the close to all-time low yield of the S&P 500 at just over 1%. The last time it was that low was September, 2000. This sort of valuation measure matters for understanding the landscape but isn't very helpful for timing. When the next bear market starts, chances are the dividend yield for the index will be similarly low to what it is now and will be a great hindsight tool for people who will say they correctly called the bear market. 

In reality, maybe the next bear market already started or maybe it won't start for months or even several years. I obviously have no idea which is why I try to position a little bit of the portfolio to have some anti-fragile traits even while stocks are going up. BTAL tends to benefit from stock market disorder (using disorder as a synonym for panic-inducing decline) and there are some others of course. 

If the question is does an all time low in SPX dividend yield mean a bear market is coming but there's no way to know beyond a guess when it will start, our answer here drifts to having exposures to things that can benefit as I just mentioned as well as things that just go about their business no matter what is going on, I think catastrophe bonds are one example of that category, various forms of arbitrage and long/short too. 

It's a mistake though to completely bail out of equities. If you just dial it down and that turns out to be a tactical mistake, you still get some equity growth as opposed to none. To Barron's point, I do think yield or "yield" as the case may be is important. If an equity sleeve, whether a percentage close to normal or not, can provide growth, peeling out an income stream that is independent of the growth can help offset equity declines and volatility. 

Of course that last sentence is the argument for owning bonds in the traditional sense but as we talk about ad nauseum, traditional bonds don't reliably get it done anymore. 

Part of the solution could be a small slice of a levered equity fund which is an idea we play around with sometimes but those funds have their obstacles and risks. We just looked at the Calamos Autocallable Growth ETFs (CAGE). The issue there is the need to constantly change how much leverage there is to maintain the volatility target. Something like ProShares 2X S&P 500 (SSO) can track twice the S&P 500....except when it doesn't....but also if the S&P 500 500 drops 40% causing about an 80% drop in SSO could have a path problem digging out of the 80% hole depending on the nature of the recovery. We also recently looked at WTLS from WisdomTree which is 90% simple beta and 90% equity long/short. It's been a while since we checked in on the Miller Value Partners Leveraged ETF (MVPL) but that could be a way to capture this effect, it toggles between simple S&P 500 exposure and 2X exposure based on technical indicators. It will be in the 2X fund most of the time because the equity market goes up most of the time. 

Since inception MVPL has compounded at 28.15% versus 29.94% for SSO and 18.85% for SPY. A lot of the gap to SSO is the fee but you can see from the drawdown chart that it probably had unlevered exposure for at least some of the Tariff Panic. I think there will eventually be a way leverage up with fewer structural risks than the current crop of funds but we'll see. 

We've had better luck sorting through the fixed income substitute and alternative spaces. A new fund for us from the RCM report I referenced yesterday is the Victory Pioneer Multi Asset Income Fund (PMFYX). It really is multi-asset.

It says equities but really it's dividend equities. "Equity-linked notes" is interesting, that's pretty close to being an autocallable sleeve. It may be structured notes which are very similar, an easy way to think of it is that autocallable funds give daily liquidity to the structured note world. 

It's not all sunshine and roses for PMFYX but you can see the yield has been pretty high in most years. Gemini said it is mostly economic yield as opposed to capital gains and Yahoo Finance seems to corroborate that.

There's not much CAGR left over after taking the distributions out which is why I don't think you should bail on equities. Let that give the portfolio growth when it can, PMFYX isn't going to do that. 

So putting this together without the leverage component;

The following starts with $800,000 and takes out $12,500 per quarter which is obviously quite high.

The return of Portfolio 1 absolutely lagged behind 60/40 but the ride was much smoother and part of this project is to address whether the record low in equity dividend yields is a harbinger of a bear market. Portfolio 1's total return was pretty close to 60/40 despite having less than half the equity exposure, Portfolio 1's beta was 0.31. If a bear market does start and equities get killed, Portfolio 1 has a decent shot of going down less. 

This is a very differentiated portfolio and as we've looked at countless times with countless versions of this same idea, actually living with differentiation can be very difficult. 

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.

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.