Black Sheep Portfolio

A couple of weeks ago, we looked at a blasphemous portfolio that combined derivative income and buffer funds. It was blasphemous because while so many professional market participants hate them, many individual investors love them. The results from what we looked at were fine despite the various flaws that derivative income and buffer funds have. They do have flaws and while hopefully we can learn something from these funds, the flaws don't go away. 

Either as a coincidence or maybe prompted from the above linked post, I've been having a conversation over LinkedIn with with a portfolio manager at another firm that uses buffer and floor products somewhat heavily. As a very round number he mentioned a 35% allocation to buffers and floors. That seemed high but according to Copilot, that is well within the norm of models that use these funds. Moderate model portfolios tend to range from 30-50%. I wouldn't have guessed that but there you go. 

It's a short period available to study. BJUL is a buffer fund that we have looked at a few times. It protects the first 9% down for one year while allowing 18% upside. BJUL just reset on July 1. SFLR sort of does the opposite, there is exposure to an initial leg down but offers more protection if the S&P 500 goes down a lot. HEQT uses puts to hedge and USMV is optimized to have lower volatility than the broad market. Here's a summary from Claude;

In 2022, BJUL was down 7.38%%, USMV was down 9.42% and HEQT was down 8.25% compared to 18% for the S&P 500. 

I wanted to update the blasphemous portfolio to be even more hated with a value ETF and low volatility managed futures. In addition to the negative sentiment toward buffers and derivative income, it seems like very few people are interested in value stocks and low vol managed future is an odd ball that is worth exploring more. 

Either version really is a Black Sheep allocation but even still, with nothing I'd want to own, the results are interesting.

The intuitively weighted version yields less than 2% while risk weighted version yields about 3.70%. The compounded real returns were 6.19%, 4.60% and 6.01% respectively. 

There was no place to hide during the 2020 Covid Crash, the important thing from that event was simply not to panic. That was a fast decline and fast declines tend to snapback most of the panic very quickly. In 2022 though, both versions of the Black Sheep portfolio was dramatically better than 60/40. There was no real help in the Tariff Panic of 2025.

To the extent the Black Sheep portfolios did well, there is some equity beta to capture upside and they avoid bond duration. The blending's result is obviously close to 60/40 most of the time which is ok but differentiated when most needed in 2022. In terms of weaknesses, 85% of the portfolio has some sensitivity to equity downside which again, was fine in 2022 but not during the few fast declines that occurred during the back test. 

I have no argument about this combo being optimal but it is valid. Something could go wrong with a buffer fund or index based derivative income fund but that hasn't happened. Market cap weighting obviously hasn't malfunctioned but has cut in half a couple of times this century and while that's not a malfunction (repeated for emphasis) cutting in half is a rough thing to endure. 

Trying to apply any of this to real life, putting 35% into one value fund like VTV is not terrible. Maybe it would lag market cap weighting and other factors or maybe not, no way to know but the structural risk is pretty much null. If you want to do something substantial with buffer or floor ETFs, I would suggest breaking that up into funds from different providers. It's not that I expect something bad to happen but where there are derivatives and complexity, there's no harm in diversifying issuers. 

One last chart about managed futures that I thought was interesting in terms of capturing performance dispersion. 

The chart only covers 15 months back to MFUT's inception. QMHIX and MFUT are both relatively volatile implementations and the difference is huge. Over the next 15 months, maybe MFUT will outperform by that much, there's no way to know. Most clients have exposure to managed futures through BLNDX and another fund that is just managed futures. Managed futures is great but if you want to go heavy, use more than one fund. 

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.

Deeper Dive On Equity Factors

We've talked several times about the challenges of using multi-factor funds, most recently here. I believe factors can be effectively blended together but it probably makes more sense to do it yourself than buy a multi-factor fund. One point I didn't emphasize in the most recent post but have talked about before is that blending factors together in one fund can result in all the moving parts diluting the multi factor effect such that you end up closer to market cap weighting than what you originally intended. 

QVML which targets quality, value and momentum is 39% tech and 11% communications compared with 37% and 10% respectively for iShares S&P 500 (IVV). Other than iShares MSCI USA Value (VLUE) which is 38% tech (due to the huge run up in Micron), there aren't too many value index funds that heavy in tech yet somehow, QVML is supposed to give access to value? 

Finominal did some research on different ways to access multi-factor strategies. 

Combination models blend together stocks from each factor so if you built a multi factor strategy with two or three funds you'd be building a combination model. Intersectional means picking stocks that score well on all of the factors that a fund is trying to access. 

Copilot says QVML is a combination fund and that Goldman Sachs Active Beta (GSLC) which adds low volatility to quality, value and momentum, is intersectional. 

Um,

And the results are similar to each other and the S&P 500.

Yes, GSLC lagged behind the other two but that chart doesn't recreate the result that Finominal got. The SPMO/SPHQ/SCHD combo we've played around with here and that I've used in place of domestic market cap weighting in client accounts, has differentiated a little better than the above with almost 150 basis points of improved CAGR and noticeably lower volatility but not dramatically lower. 

Kind of related, ETF IQ reported that ETRACS is closing two ETNs that seem interesting. They have no assets to speak of but still interesting. MTUL is 2x momentum and USML is 2x low volatility. I tried to find a 2x low volatility fund for a blog post but USML didn't pop up. I think it was Cliff Asness that talked about leveraging up low volatility equities. 

SSO which is 2x SPY has tended to track double the reference index over longer periods (it's not infallible) so it is interesting to see MTUL and USML not do that very well except for the volatility on MTUL versus MTUM.

Going year by year there were a couple of instance where they did get very close to the 2x the result.

The idea is interesting but the result this way a little less so.

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.

Even More Unconstrainment

Let's continue yesterday's conversation about unconstrained strategies. 

Starting with another ETF from fund provider Monarch, the Monarch Ambassador Income ETF (MAMB) seems to delve into unconstrained territory. 

How has that impacted results versus AGG and IUSB?

MAMB was very close to AGG and IUSB until 2025 when its allocation to gold (per Copilot) added to returns. In 2022, there was no differentiation versus AGG or IUSB.

Their idea though can be implemented with different funds to get a differentiated result. Their idea is valid but could benefit from being more unconstrained. The following allocation is the where I would start trying to use MAMB's process.

TYLD can flip between short term bills and longer term income sectors based on how wide spreads are. Since its inception in 2024, TYLD it has only been in T-bills. I am using TYLD as a proxy for long term treasuries because it can switch to that if it ever becomes attractive to will but avoid that unreliable volatility in the meantime. Where TYLD has only been in T-bills since inception, we can use SHY which is also T-bills to get a longer look than just two years. 

The MAMB replication outperformed thanks to less exposure to duration which has probably been one of the most important themes we've talked about over the history of this blog but less duration also helped bring the volatility way down versus the MAMB ETF and IUSB. Usually, I include a slice of these studies to catastrophe bonds but I didn't think anything in MAMB's holdings was that close to cat bonds. Replacing half the BKLN allocation which SHRIX improved the CAGR by 30 basis points and lowered the volatility by just a couple of ticks. 

As I said yesterday, I think of unconstrained as looking different from some default fund or strategy. There's nothing wrong with MAMB when considered against AGG or IUSB but if an investor does not want their equity offset to look like AGG or IUSB then MAMB won't be the best solution. It's still interesting and obviously I think there is merit in their idea but with different funds. 

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

What's In An Unconstrained Name?

This morning I stumbled across the Monarch Volume Factor Global Unconstrained ETF (MVFG). The fact sheet wasn't crystal clear but Copilot says the fund allocates based on fund flows, will typically be an equity proxy but has a process for flipping to treasuries. 

We've looked at the Artisan Unconstrained Fund (APHPX) a few times and that is essentially a hedge fund. It's not an equity proxy, it intends to be more of a macro hedge fund strategy.

A third one that we've never looked at is the Manning & Napier Unconstrained Bond Fund (MNCPX). It is a fixed income strategy. It's a three star fund so pretty ordinary and while it resembles AGG (correlation is 0.72), there is differentiation, in 2022 it was about 650 basis points better than AGG. MNCPX is a bond fund that hopefully adds value for its holders.

So that's three different funds, all "unconstrained" but all doing very different things. The first point today is the importance of sifting through how a fund is named to make sure you understand what it does. It's not obvious to me how the word unconstrained fits with MVFG, which is fine, from Monarch's viewpoint I am just some rando on the internet, the fund will either do well or not but on first glance there doesn't appear to be anything obviously wrong with it. 

I like the word unconstrained. In the investing context, it means looking different somehow and to me it implies being innovative in an attempt to problem solve. If the default portfolio is 60% SPY/40% AGG or IUSB, that is a problem that needs solving for reasons we've talked about in hundreds of posts. 

Something related, a paper from Alliance Bernstein titled The 100 Year Portfolio: A State Of Mind Rather Than An Allocation, along with a TLDR from Idea Farm. Maybe 100 years isn't something we need to think about but there were a couple of interesting ideas all the same. 

Across the past century, a 60/40 portfolio’s chance of beating inflation approaches a coin flip, despite unusually strong post-1980 performance.

This hits a point we make very frequently here. There was a 40 year run that concluded in late 2021 of fantastic bond returns that cannot be repeated. Carving out that 40 year period, 60/40 isn't so hot according to the paper. If 60/40 with the 40 in AGG or IUSB is the default and the great bond bull market is over, then we're back to coin flip territory. Again, that is a problem to solve. 

Alliance Bernstein estimates a real return of 4.5% (CPI plus 4.5) for equities going forward versus the historical 6.7%. We've talked about a common return target of CPI plus 5 using a diversified portfolio for endowments and foundations. So 4.5% may not seem so bad but I take from the paper they mean 100% equities to get CPI plus 4.5 not an endowment style allocation which typically is not 100% equities. 

Broken record, this is a problem to solve in an unconstrained manner with differentiation and innovation. We express that here and in client portfolios with trying to make portfolios a little more yieldy (cat bonds do this), have a slice of negative convexity, managed futures, alts that aren't typically sensitive to cycles and a couple of other ideas. 

There is no way to know whether 4.5% will turn out to be correct, it doesn't make sense to me to try to predict when or if bad things will happen, it is far more robust to simply be ready if it ever happens. 

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.

Managed Futures Ain't Easy

From Meb Faber;

And for what its worth, plugging Meb's question into Copilot came up with a range of 15-25% and then zeroed in on 20%. The following are built using SPY for equities and an even split of QMHIX and DBMFsimulated for managed futures. Both are volatile, QMHIX is a full implementation and DBMF is a replication strategy. 

I tried to color code the backtest results but not sure how helpful that is. Putting 40% in managed futures optimizes the Sharpe Ratio, the Calmar Ratio and has by far the lowest drawdown. 

You can see in the year by year where the various equities/managed futures combos lagged by a lot. 

The second table is the definition of line-item risk. We said before and others have also observed that every backtest with managed futures looks fantastic but the experience of owning the strategy is very difficult, especially in size. 

There's no answer that makes owning managed futures easier for when it is lagging. That is why I keep client allocations toward the lower end of the scale and blend in other alts (diversify your diversifiers) that give the opportunity for a similar diversification benefits in the good times for managed futures without the huge drag during periods like 2016-2021. 

Updating the above, Portfolio 1 introduces Eric Crittenden's idea that underlies BLNDX (he uses all country not domestic though).

This supports Eric's thesis but there have been a couple of shorter periods where BLNDX has struggled, ditto funds the combine domestic equities and managed futures. 

I am a huge believer in small doses of managed futures but repeating the point, there is no magic bullet. There's no solid conclusion to this post which is similarly frustrating in the same way the managed futures can be frustrating. 

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.

Gila Monsters & Personal Finance

We're in Tucson this week and this guy paid us a visit this morning.

It's a Gila Monster, they pop up on our ring camera every so often.

The second volume of How I Invest My Money is out. I read the first one, it is interesting to hear how various people invest ranging from sounding complicated in some cases to surprisingly simple in other cases. Surprisingly simple is not a criticism. 

Sort of related, the WSJ posted Readers Share How Much Cash They're Keeping In Portfolios. Most of the readers in the article range from sort of a normal range of cash like 5-10% while the youngest guy at 40 years old said he was 90% cash. The comments are worth reading. A log of people lean heavy to equities, several talked about leaving X number of months worth of expenses in cash, similar to how we frame it, and quite a few tried to warn the 40 year old who is 90% in cash that he's being too conservative. 

I've shared  some of this over the years. The most unusual part of how my wife and I invest is that we have very high percentage in cash. Meb Faber has talked about advisors being leveraged to the stock market already before investing anything. I stumbled into this concept for myself before Meb talked about it publicly with the added wrinkle beyond Meb's context being that my spending time constantly tinkering and trading my own accounts would take away from what I should be doing in terms of my fiduciary obligation. I have seen other advisors unable to sit still in their own account, pretty much defying every tenet of good investing even if my fiduciary comment is too harsh.

If I get to the point where I am stressed out about my accounts, either because of large declines or fomo induced by greed, then I could see where that emotion could drive decisions made for clients. I've never gotten anywhere close to that point so maybe this theory is wrong but I have seen advisors both panic and get greedy. Note that making a decision that turns out to be incorrect is different than making a decision out of fear or greed. Managing portfolios is a series of decisions and not every one will be correct. 

I used to have about 25% in risk assets and that has probably gone up to 35% (mostly equities and a little Bitcoin) as a function of growth and withdrawing money last year for the down payment on the Tucson house. We have maybe 10% in alts including managed futures, 20% in short dated paper and fixed income substitutes and the rest in cash. Most of what we own, clients also own other than Bitcoin (one or two exceptions) and one oddball mutual fund. The asset allocation is different, the holdings are not. 

It is still my intention to continue to work but as I've mentioned before, it is likely that my income will go down, clients are generally older than me and I don't spend time prospecting for new clients. Assuming I am correct about my income going down, it should still be enough to cover our basic expenses for quite a while which would hopefully allow me to stick to my plan of waiting until 70 to take Social Security. If I make it past 69 before taking it, I will consider that as going to plan. 

Right now, we are not contributing meaningfully to retirement accounts so we can quickly pay off the Tucson house. We took a 30 year loan with the intention of trying to pay it off in four years +/-. The interest over the entire term would be more than the principal. At this point we've paid off about 20% of it so we're mostly on track even if we end up off by a year. If I am 64 or 65 when we pay it off, then we'd be able to make meaningful contributions to retirement accounts. This year will be small contributions. 

If you're not taking money out and can avoid overtrading, then whatever you have in equities will double over some time horizon or maybe even triple. I have to take RMDs in 15 years. Over the last 15 years, testfol.io has SPY going up 787%, $10,000 grew to $88,000. If over the next 15 years if it has 1/4 of that growth rate, that's still better than a double. Is that meaningful for you? It would be for us, even with our low percentage.  

I go very long stretches without making any changes other than investing contributions. Usually, the best thing is to just let the market and your portfolio work for you without constant tinkering and trading (sort of repeated for emphasis).

The final point to make is that resiliency and optionality, or at least the pursuit of them, is embedded in everything we do from a personal finance perspective. I don't want to be overly reliant on one narrow outcome that hopefully goes the way it should. 

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 Fear Mean Reversion?

Bespoke had a short blog post about rebalancing plain vanilla 60/40 portfolios. It noted that with no rebalancing, a portfolio implemented at 60/40 right after the financial crisis would now be 92/8 which represents massive outperformance by equities. Yes, equities will outperform the vast majority of the time and probably by a lot but I think they were saying the result that took 60/40 to 92/8 was especially strong for equities. 

Always remember that nothing lasts forever, though. There’s an old saying that the market exists to cause the most amount of pain for the most number of investors, and if that’s the case, the over-exposure to stocks is bound to cause a lot of pain when the trend of the last 17+ years comes to an end.

They closed out the post with a warning about mean reversion. 

Testfol.io says that for the last 17 years, the S&P 500 as represented by the SPY ETF has compounded at 14.83% compared to 10.87% for SPY's entire 33 year history. So yeah, equities have been on a heater. They might mean revert, or not there's no way to know. We've devoted some time lately to gameplanning if there is some sort of mean reversion but we've talked in terms of a lost decade for equities but it's the same idea.

I don't want to try to guess what or when, just be ready if. 

It's not clear that Bespoke is saying to rebalance into bonds but I think Morningstar is saying that here. It's a remarkably shortsighted piece from Morningstar. The basic argument is that bonds can help you lose less. Ok, maybe there's something to that and maybe that's good enough but they cite a lot of backward looking data that includes decades of unrepeatable bond market performance. It literally cannot be repeated which incorrectly skews their premise. There might be a way to make their point with data that's actually useful, or not I don't know but wow, it misses badly. 

I've posted essentially that same chart many times and asked, what do you want your equity offset, bonds in Morningstar's context, to look like? There are countless alts and combinations of alts to get a result that is similar to the blue line in the above chart.

One question we've been trying to answer is whether a small allocation to autocallable funds should be part of the the solution for offsetting equity volatility or adding yield or both.

Those are what I believe are the three oldest funds in the space. I highlighted the volatility numbers. SBAR and XV are pretty close to TLT by that measure but with much more yield. Yes the total return numbers stand out too but if equities revert to some mean then I would expect the that column to be less impressive. If the equity market doesn't implode, then the autocallable funds will still pay out but keeping up with their distributions might be more difficult. 

As more of these hit the market, we can learn a little more about them. Based on the following on a day when the S&P 500 was down 69 basis points, there was plenty of downside sensitivity. 

IACL just started trading today and the last four listed started trading last week. I have no idea yet whether I will ever use an autocallable fund but I think it is a mistake for advisors to not make some effort to try to understand them. 

If you are considering them, I would suggest a small allocation, using different fund providers and making sure you're not duplicating the counter party banks. 

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.