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.

Build Your Own Annuity With Daily Liquidity

A few days ago I mentioned this passage from a Barron's article

A popular choice is a fixed indexed annuity with an income rider. Fixed indexed annuities offer protection against market downturns by limiting upside in a bull market. With an income rider, there’s the option to turn on an income stream at any time and collect guaranteed income for life.

And then I quipped

Or, instead of an annuity, someone could use a buffer strategy for a while and then flip that into derivative income when they are ready to take income (it may not last for life though).

I've been thinking about that I think there might actually be something to it. A few times over the last couple of years I've talked about the idea of circumstantially annuitizing part of the portfolio, not buying annuities, more like creating your own annuity (annuitizing) without the complexity or expense. 

After that post last week, I plugged it into Copilot for a second opinion on the idea expressed in my quip. It liked the idea a lot but there needs to be a grain of salt taken with that sort of feedback, it also said I was tall and unusually handsome (joking). The strategy underlying the first half of the fixed indexed annuity (FIA) reads like a buffer fund. Here's a quick study of buffer fund strategy.

BUFR has more equity market sensitivity than BALT. Just using BALT without any BUFR, has compounded at 6.05% since BALT's inception with a volatility reading of 3.27%. The blend I am trying to create would come close to what bonds used to do before interest rates bottomed out in late 2021.

I'm going to circle back to the treasuries backtest in a minute so disregard the dollars and focus on the growth rates and volatility numbers. They're close to the buffer blend numbers.

Let's set up an example. An investor in 2005 is 55 and wants to retire in 2015 at 65. In 2005 he has $500,000 in his 401k in a balanced fund like VBAIX and $250,000 in a taxable account. He puts the $250,000 into 7-10 year treasuries and leaves it alone while he continues to work. After ten years, the $250,000 becomes $429,476.

At year end, 2014 he is ready to activate the "income rider" from his self created annuity and he puts the entire $429,476 into SPXX with the plan of taking out $5000/mo. That's not sustainable but it can function as a bridge to taking RMDs at for him would be at 75, from the 401k that was subsequently rolled into an IRA. SPXX is a derivative income closed end fund with a long track record. 

At $5000/mo, the original $429,476 invested in SPXX depletes in the summer of 2025 as he is about to start taking RMDs.

Back to the balanced fund in his 401k which we said was $500,000 in 2005.

When SPXX depleted last August, the 401k>>Rollover IRA if untouched, grew to $2,301,887 which allows for $92,075/yr in withdrawals or $7692/mo assuming a 4% withdrawal rate. The $7692/mo is a little bit ahead of inflation. Starting at $5000/mo in 2015 would now equate to $7110/mo accounting for inflation. 

The ten year depletion of SPXX is worth digging into a little more. According to Copilot, the "lifetime income from an FIA usually averages out to 12-14 years" for those who take the income. Not everyone does. So the ten year window fits into individual circumstance we created but falls short of 12-14 years. However, starting this exercise in 2005 and then the SPXX income rider in 2015 was all done when there was far fewer choices available. 

A combination of different strategies with completely different risk factors can be blended together to nudge up the "yield" and very likely extend out the depletion date. Things like catastrophe bonds, closed end funds, derivative income funds, autocallables (a different kind of derivative income fund) and so on, even Annaly Mortgage that we looked at recently, can be sized and managed to mitigate risks in case something bad happens. We've built out this yieldy concept before. 

Let's see if I can articulate this point clearly but with some of these products that are starting to build a longer track record, yes there is absolutely risk but at some point you go from looking out for and managing risks to looking for a ruinous Black Swan event. Not the same thing. We might be at that point with buffer funds. Here is a long read from Morningstar about how well investors are doing in buffer funds with the implication that those investors have the correct expectations.

There's now a wide swath of buffer funds. The arguments against them are valid and generally correct but they haven't malfunctioned, broken or needed to invoke any sort of immediate termination. So using them might be better thought of as dealing with something that is suboptimal. AQR says instead of a buffer, investors would be better off with less equities. If someone is looking for an equity strategy with less volatility, then sure, just own less equity. I don't think that's what we're talking about here. Can a combo of buffers be put together to replace what treasuries used to do? That seem plausible to me, we just did it. 

Similar story with derivative income funds. If you buy AMZY, you are not going to get what Amazon does. Thinking you're getting the stock is the wrong framing. For AMZY to be successful, yes, the common needs to not blow up but AMZY is about harvesting the volatility of Amazon for a different outcome, "yield" not growth. And doing that comes with its own risks including depletion at some point if all the distributions are taken out. 

Is any of this worth it? Gemini says that every year, there are between 850,000 and 1.3 million FIAs sold every year and notes the annual fee for the income rider is 1.2% and the surrender costs (that is where the commission gets paid) is typically 8% but I should note I thought the surrender charges were more like 7%. 

That many people buying FIAs (it does seem high but who knows) tells us there is demand for positive compounding that doesn't have full exposure to the equity market's volatility. Assuming no malfunction with the product or the insurance company, FIAs before the income rider do that and so do buffer funds. The income rider pays income for life and there is demand for that too but as we saw, that isn't necessarily a long time based on averages. The next question is whether a bridge strategy or depletion bucket can last sufficiently long until the next relevant financial milestone. Taking 10% out per year from a very high yielding portfolio that lasts for 12 years seems plausible but there can be no certainty. 

Some sort of idiosyncratic risk to one type of alt can be pretty easily diversified away which leaves us back to worrying about some sort of macro Black Swan that would derail the concept. But that can happen to insurance companies too. My brother used to work in the industry and he put our mom into some sort of annuity in the late 80's and the insurance company went bust in 1990 or 91 so insurance companies are not immune. That might be a contributing factor to my bias against annuities.  

There are some complex details to drive by quickly that should be delved into if you go down this road. Return of capital as part of the distribution lowers cost basis so there's no tax on that part of the payout until the cost basis goes to zero. At that point all ROC distributions are taxed as capital gains. If you put $10,000 into a crazy high yielder and over a period of many years taking out the distributions leaves the value of the position at $1000, the the capital gains tax at that point would be quite low. Including a narrow slice of your "income rider" portfolio to a crazy high yielder seems the most likely way to run into this issue. 

Also, whatever faith you put into an insurance company guaranteeing anything for life, that does not exist for building your own annuity with buffer funds and then moving to derivative income and other high yielding niches.

Annuitizing yes, annuities no. I've said before that the fund space will figure this out and there are some product lines that sort of go down this road so I think it will happen but in the mean time, this is interesting to me.

Copilot said no one else has written about this but if you know about anyone else who has looked at this idea, please drop the link in the comments.

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 Challenges Of Multi Factor Funds

Blending several equity factors into one fund can be difficult to pull off in terms of capturing the intended effect. A good example/microcosm from Friday with the Invesco S&P 500 Multi-Factor ETF (QVML). The ticker symbol tells you the factors; quality, value and momentum for large cap stocks. 

The first three fund target quality, value and momentum respectively. I did a quick review of QVML in March. The combo of quality, value and momentum is intriguing and has had the tendency to outperform market cap weighting but when I wrote about the fund in March I noted that it's huge weighting to tech wouldn't allow it to differentiate a whole lot.

The above chart is very short of course, below is 2022.

For 2022, using three separate funds worked much better than QVML.

For the longer period, the three individual funds blended together lagged SPY and QVML because it owns less tech than SPY and QVML. Is any of this worth it? That's up to the individual of course but for anyone trying to diversify at the factor level, a multi-factor fund might not be the answer. 

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.