Get Out Of The Business Of Making Predictions

For the last couple of days we've talked about the newly listed Fundrise Innovation Fund (VCX) which is a closed end fund that inflated to a 1900% to NAV on Wednesday, then yesterday fell to just an 1100 premium to NAV. At the open, it took another huge leg down. 

The NAV remember was reported/estimated to be about $20. The drop on Thursday is being attributed to news that Citron Research went short with the the primary thesis being "simple math." VCX holds a lot of the "right" companies so that is intriguing but with reports floating out there that SpaceX will go public in June or July and Anthropic in the fall, given the market caps, the odds that you will end up with them in something you already own are pretty high. 

The WSJ piled on to Blue Owl with questions/observations about its recent loan sale from a few weeks ago at just a tiny discount to par. It read to me like they sold the good stuff to larger pools doubling down on their existing stakes and leaving the inferior loans still in the funds. 

Regardless of whether my take is right or not, this whole thing is a complexity bourn of greed (chasing yield) that was easily avoided in real time. Dani Burger shared an anecdote on Bloomberg from some interview she did where the guest said her parents are older and need liquidity and income but that their advisor was pitching private credit to them. This is complexity that was and is easily avoidable, repeated for emphasis. 

AQR filed for an interval fund that will be called AQR Delphi Long Short Fund. The filing reads like it will have a similar strategy as client/personal holding BTAL, "...long-basis in assets the Adviser deems to be attractively valued, high quality and, low beta (lower risk) assets and on a short- basis in assets the Adviser deems to be expensive, low quality and high beta (higher risk) assets."

Long/short is a fascinating strategy for how much ground it can cover. We've used the terms long biased, market neutral and short biased to cover the space. We've looked at the Invenomic Fund (BIVIX) as one that appears to be able to go from long biased to short biased, having made one or two great calls leading to a couple of massive up years earlier in its existence. Managed futures is also a version of long/short. 

Equity long short is probably like managed futures in terms of anyone want to go heavy should probably use more than one fund. There's a lot of performance dispersion. 

I use short biased, neutral and managed futures for long/short. 

The war has become a real market event. Hard to say at this point how serious it will be in market terms but this is a noteworthy reaction. 

Eight percent in a month is kind of a fast decline. It's nothing like the Tariff Crash last April or the Covid Crash in 2020 but it is something. You might know from reading this blog that I put a lot of effort into trying to prepare clients and the portfolio ahead of time for when things get bumpy (or worse). I constantly write about the strategy and tools I use. Now that an event is underway, most of the work should be done. Whether or not I make another tweak or two depends on an unknowable future sequence of events. The point is having a process you believe in, more like have unyielding faith in, and letting it work without being in the business of trying to predict anything or (over) reacting to whatever is scaring markets at the moment. 

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.

Remember Country Funds?

Yesterday we looked at funds that offer access to private equity including Fundrise Innovation (VCX) which is a closed end fund that just started trading last week and had rocketed to a 1900% premium to its NAV as of yesterday's close. A different story today.

So now it's only trading at an 1100% premium to its NAV? This stuff is fun to look at and learn about but seriously, keep your money in your pocket. 

Eric Balchunas from Bloomberg posted this chart.

His point was that if you think the S&P 500 is concentrated, that's nothing compared to most other country benchmarks. In my time writing at thestreet.com, I wrote about many of the iShares country funds and would mention the sector composition in this context. From 20 years ago, it would have been easy to wind up with huge overweight in something like financials. Today, if you have a core of some S&P 500 fund and add iShares Taiwan (EWT) 68% tech and iShares Netherlands (EWN) 32% tech, you'd have less diversification than you might think. 

Someone wanting to go big on semiconductors and foreign could instead use ProShares S&P 500 ex-Tech (SPXT) for domestic and then EWT and EWN for their tech exposure for example. That's really just an example of how to look through to the sector level in these funds, not something I'm doing. 

Let's game this out, below. The 30% in EWT gives the overall about 23% in tech. 

Austria EWO is a source of financials, Switzerland (EWL) is healthcare and industrials and Peru (EPU) is materials. I used XLY to add the US and consumer discretionary and KXI is global staples. 

Copilot with the assist.

If you give this method more thought, I might suggest reducing the financial sector exposure a little bit. That sector tends to be big in many country benchmark indexes. The backtest for this versus All Country ex US, All Country including US and the S&P 500 was fascinating.

Calling it fascinating might be a little optimistic but the result is pretty much identical to All Country World (ACWI), that's the one that includes the US. I pulled the allocation out of the air pretty much. I had some understanding of what some of the country funds are heavy in with regard to sector composition. I just used AI to do the sector math. AI could obviously help dial in the sector weightings better and then help with diversifying risk. I tried a little bit with different types of economies like commodity based and service based and so on but I would not take today's theory as optimal. 

Quick personal note, I am thrill that baseball has started. Most afternoons during the season I am on my laptop with a game on, very much a joyful thing for me. This guy has what might be the greatest nickname in the history of sports. His nickname is The Password. 

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.

Trying To Figure Out Gold

Have you heard about the ERShares Private Public Crossover ETF (XOVR)? As the name implies, it is a mix of private companies and public ones including a large weighting to SpaceX. There has been a lot of coverage of this fund, most notably by Jeff Ptak from Morningstar. There have been questions about not marking to market and whether the fund owns too much SpaceX in terms of regulatory limits and what they're going to do about that.

The RONB ETF also owns SpaceX but per the fund page, it owns less. The Destiny Tech 100 Fund (DXYZ) is a closed end fund whose largest holding is SpaceX along with a few others that are probably familiar. It currently trades at a 32% premium to its net asset value. The structure of closed end funds is that the share amount is fixed, unlike an ETF, so market pricing is heavily influenced by investors' supply and demand, more so that with ETFs. 

Last week a new closed end fund started trading. Actually, it looks like the Fundrise Innovation Fund (VCX) has existed but is now available as a closed end fund in a brokerage account. It started trading last week at $31.50 and it closed regular trading today at $380 and is up another 10% after hours.

Grok estimated VCX' NAV to be $18.97-$20 as of March 19th. If accurate then the fund is trading at 1900% premium to NAV. 

If you gotta have this exposure and it ends up going horribly wrong, like because you bought with a 1500% premium to NAV, you can sell right away. The point is there are ways to access this part of the market without locking up your money. Similar to Cliffwater, there are ways to get most of the effect without the hassles that go with illiquid products. 

Bloomberg and the FT took runs at trying to understand why gold has sold off since the war started. There were some vague thoughts including the idea that gold was overbought coming into the war which kind of jibes with what we talked about, that the gold market might have priced something bad in already and then sold on the news. There was also a sentiment that people have been selling what they can. 

There may be no explanation that will satisfy anyone who is curious or invested but a little bigger picture is the idea that we talk about a lot which is that no diversifier is guaranteed to work in every single event which is why it is so important to diversify your diversifiers. If an investor would consider 20% in gold for times when things hit the fan, why not take that 20% and split between several different diversifiers in case gold, or something else, doesn't work out. If they all work, great. It's not impossible that none would work but that is a very remote possibility. 

Bespoke mentioned the large declines in some of the larger tech stocks.

Seems like a good time to check in on some of the crazy high yielding derivative income fund that we look at every so often. A lot images coming. 

Microsoft isn't as volatile as some of the others so it is interesting how closely the total return of MSFO tracks to the common. 

Google is a touch more volatile than Microsoft and the total return of GOOY is pretty far from the common, more than I would have guessed. 

Nvidia is more volatile still and again the total return of the YieldMax equivalent is pretty far from the common which we've seen before.

With all of these, there is path dependency risk. It hasn't been much of a problem for MSFO up to this point but has been for the other two. 

We've looked at ways to use these where small slices can add meaningfully to a portfolio's yield without being a hideous drag on returns like yellow lines in the above charts.

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.

Using Volatility To Lower Volatility

Let's follow up on yesterday's post about barbelling and capital efficiency, continuing to use Direxion 3X Bullish Daily Technology ETF (TECL) as our source of volatility and driver of returns. 

The framing for this could be thought of absolute return trying to get CPI plus some amount. A real return of 2% is generally a benchmark for these sorts of things. Plain equities of course have a much higher real return and also much greater volatility than absolute return.

The funds in Portfolio 2 were chosen so that we could get a pretty long period to study. There are of course far more sophisticated strategies available in retail accessible funds now with daily liquidity. This concept might be for someone who is ahead of where they need to be but still needing a decent real return in case price inflation does something squirrelly while avoiding the volatility that goes with a "normal" allocation to equities. Interestingly though, based on equity beta, 10% in TECL would be like having 40% in the S&P 500. Sort of. I wouldn't assume that to be a linear relationship but it speaks to this form of capital efficiency providing a decent percentage of net equity exposure with very few dollars at risk.

With that longer term context, here's a shorter period that takes advantage of some newer funds. 

For this period, inflation compounded at 3.99%. I used SHRIX for catastrophe bonds. That big dip in late 2022 came from Hurricane Ian. The market reacted like there would be big payouts but there were actually no triggering events. 

Of course, if I ever wanted to actually implement this anywhere, I'd divide the 90% not going into TECL between a dozen different things to avoid the idiosyncratic risk of having 90% in one strategy. I would want to avoid the idiosyncratic risk of having 20% in one strategy let alone 90%.

If you're wondering what the hell Cliffwater is doing there, that story is evolving inside of the bigger private credit story. Bloomberg did a very deep dive into the funds and the structure of the company itself.

The big takeaway for me is the complexity of both the funds and the company. There was no wrongdoing implied and for that matter no poor investment decisions either. They're heaviest in loans to tech companies but so is the entire industry and actually the percentage isn't so big that you'd think yikes, why so much. 

In a recent blog post mentioning Cliffwater and private assets I quoted someone as saying "no one wants to be the last one out" which seems more like what is going on. A lot of people want out at once, most funds are structured to only let 5% out every quarter and the requests for redemptions are generally exceeding the 5% caps. Cliffwater is not immune to this. Against that backdrop, if these funds need to sell and are then forced to sell to discounted bids, it can hurt fund NAVs and reduce the amount that customers get from selling. This can all happen without the actual loans going bad. 

I included Cliffwater above is to show that the issues that go with illiquidity, lack of price transparency and the expense may not justify the returns. The returns have been good but are they so good as to justify the drawbacks of the interval wrapper? We found a couple of things that have been doing a little better than Cliffwater and there will be plenty of others not doing quite as well but pretty good all the same.

Back to our capital efficiency strategy. Copilot did not like the idea of putting 10% in TECL. It made an interesting point, that with the goal of absolute return and a CPI-plus sort of outcome, no single holding should be able to take more than 3-4% out of the entire portfolio. I countered with adding 15% in BLNDX with 5% in TECL. After some back and forth, we came up with this;

Comparing it to 10% TECL/90% T-bills.

As is often the case with these, I would not focus on the performance versus VBAIX, it is a short period to study because of how long some of the funds have been around. Part of why so many of the portfolios we look at have done better is not what we add, it's what we avoid which of course is bond duration. The volatility info and portfolio stats have more information than the growth rate. The portfolio we created today has less than 25% in equity exposure so of course it will lag behind VBAIX with more time to study but the ride for this portfolio can be much steadier and be CPI-plus.

I'd add that the portfolio we built for today's post is that it violates one of our bigger picture goals which is a lot of simplicity hedged with a little complexity. This is a lot of complexity. It diversifies the risks but it is absolutely not simple. 

One thing about trying to use Copilot is that it tends to give a heavy weighting to the worst possible thing happening to each strategy at the same time in manner that would be unprecedented. Using AI is very helpful but learning how to challenge the outputs is important too. 

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.

Face Melting Volatility

Earlier this month, the CBOE launched an index that tracks the volatility of Bitcoin. Like VIX but for Bitcoin. The symbol for it on the CBOE website is BITVX but I couldn't find it quoting anywhere else yet, but I'm sure it will soon. 

And whammy

The filing indicates it will lever up 1.5x the BITVX. The volatility of Bitcoin is 50-100 according to Copilot versus usually being 10-20 for the S&P 500. If CBIX ever sees the light of day then depending on the methodology, the volatility could run 75-150. Even if the numbers mean nothing to you, you probably have a handle on how volatile the S&P 500 feels. If you're in touch with how volatile VIX is, its volatility runs 12-25. Again, all numbers from Copilot.

We've spent a lot of time trying to learn about volatility as an asset class and using it as a strategy. I feel like I've had good luck using BTAL and SH (been using SH off and on since the Financial Crisis). I've used a couple of other things too over the years with dual idea of avoiding the full brunt of large declines and generally reducing the overall volatility of the portfolio.

Volatility can play a role in barbelling a lot of return out of a small portion of the portfolio where that small portion theoretically gives the same dollar return that a normal allocation to equities would give. 

Portfolio 1 is 25% 3x Technology and 75% T-bills. It uses the volatility of technology to get market like returns with much less exposed to risk assets. While the long term result has worked out, the path going forward can't be known and as Dennis Eckersley might say, TECL goes down 40% just to stay in shape. 

TECL's volatility runs at about 40 which helps create some understanding of what CBIX might look like. The path that CBIX will take might be like trying to hold on to an M80. What's bigger than an M80? Is there some way to use CBIX to either capture returns or provide defense? I don't know but someone will figure that out.

I mentioned the other day that as the levered and capital efficient ETFs spaces continue to develop, I think the useful direction here will be funds that double up on the volatility not the daily result. They have fewer problems with the path of returns creating a terrible outcome like the 2x Tesla ETF.

 While I am comfortable using volatility for defense, I don't know about using it for offense like we're describing today for a barbelling of potential returns but it's worth studying. 

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 Magic Factor Bullet

Research Affiliates put up a paper titled Why Value, Quality and Momentum Belong Together. The paper didn't actually provide any sort of usable conclusion, it more just outlined the merits of the three factors with a little bit on how they can work together. 

Trying to find some sort of magic bullet by blending factors is something we have toyed around with a little bit. I'm convinced there is some sort of blend out there that would be optimal but we haven't found it yet. Maybe value, quality and momentum is it. 

We use SPMO for momentum here and Copilot suggested SPHQ for quality and SCHD for value. The prompt for SPHQ was to ask for quality factor funds that actually differentiate from market cap weighting and have at least an eight year track record. iShares Quality (QUAL) for example doesn't differentiate. Copilot included SCHD in the the result for value funds, it thought SCHD would be the best value fund. I suppose it's value-ish?

My first thought was to just equal weight the three. Copilot suggested 30% to SPMO and 35% each to the other two. PRF is a Research affiliates multi-factor ETF that has been around for awhile. Multi factor isn't quite right, it screens for book value, cash flow, revenue and dividends. 

PRF does its own thing. I've never been a fan of this one but there have been periods here and there where it has outperformed. There's not much differentiation from either version of the SPMO/SPHQ/SCHD combo versus the S&P 500 until mid 2022. That year both versions were down about 9.5% versus 18% for the S&P 500. PRF was down 7% that year. 

The portfolio stats range from incrementally better than market cap weighting to noticeably better but hard to say that it is a magic bullet. 

The SPMO/SPHQ/SCHD combo has 28-29% in tech plus communications so as we've been talking about the last few days, if something terrible happens to the market and it starts in tech/communications then this combo has a chance of holding up better.

It turns out there is an ETF that blends these three factors without adding the complexity of trying to rotate factors in any way. The Invesco S&P QVM Multi-Factor ETF has symbol QVML. Copilot says QVML equal weights the three factors so this next one compares QVML to our do-it-your self equal weight version and the S&P 500. 

QVML has been incrementally better than the S&P 500 but just slightly and the do-it-your self has been slightly better than QVML.

It looks as though QVML has a combined 46% in tech/communications.

Uh oh.

Where our conversation has pivoted to how to avoid the full brunt of a tech meltdown in a portfolio that is heavy in market cap weighting, it's not clear to me that QVML can possibly do that with the huge weighting to tech and communications as well as the overlap in the top ten. in 2022, QVML was down 16% versus 18% for the S&P 500 and 9% for the do-it-yourself version. QVML might do well in a tech meltdown but building it yourself looks like it would be more robust. 

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 To Do If Tech Is Ground Zero For A Bear Market

Today let's play around with the Alps Equal Sector Weight Fund (EQL) that we looked at the other day. I wanted to try to build something out was simple with a little robustness in the face of market adversity. I built out the following, one with market cap weighting and the other with EQL. Everything except SHRIX and EQL are in my ownership universe.

They're identical except for VOO and EQL.

It probably only makes sense to consider EQL if you are concerned about technology and communications being ground zero for some sort of really big decline. EQL has lagged for having less in tech and communications so I would expect EQL to outperform if tech does something hideous in relation to the rest of the market. Both versions have much lower volatility and held up quite a bit better in all the drawdowns except for the 2020 Pandemic Crash.

As is the case with most of these exercises we do, not having any bonds with duration is a big driver of the results with BLNDX and BTAL chipping in too.  

Short post, we had a very small wildfire today that took some time. 

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.