The Pursuit Of Robustness

Bob Elliott from Unlimited Funds got interviewed by Brad Roth from Thor Financial which was posted at ETF.com. Bob has a fascinating background, he worked at Bridgewater for a long time and then started Unlimited a few years ago. Unlimited is up to four funds now and all of them offer some version of hedge fund replication. HFND is the original, HFMF is 2x managed futures, HFGM is 2x global macro and HFEQ is 2x long/short. What 2x means in this case is twice the volatility which might equate to twice the return but not necessarily. Part of the idea with these is that many liquid alts aren't volatile enough. 

With his background, Bob should be a great must listen but this interview was the best one I've heard for extracting useful tidbits. 

First, lets test drive 2x managed futures. In the interview, they talked about an allocation of 50/30/20 to replace 60/40 where the 20 goes into alts. 

For quite a while, the managed futures didn't really help much as the teens was a bad decade for managed futures. That struggle didn't really hold back relative returns though. Then in 2022, the managed futures did help both Portfolios 1 and 2. The early lag for Portfolio 1 is from having only 50% in the S&P 500 versus the other two having 60%. If you like the idea of 50/30/20, saying the obvious, you have less in stocks than in a 60/40 portfolio and stocks are the thing that go up the most, most of the time. 

They talked about HFND, Bob's first fund, being something of a fixed income proxy (my words).

Some clients own BALT as a fixed income substitute. The chart is interesting. Going back to QAI's inception, that fund has not done well but that might be a function of rates that were at 0%-1% for a long time. Now that rates are higher, that fund is doing better. I am surprised to see QAI ahead of HFND.

The motivation to use these liquid alts is to make portfolios more robust, the pursuit of robustness. Robustness does not mean perfection which I think is a great point.

The most interesting idea they talked about was that once you find robustness, you're not going to improve much from there. Basically don't mess with it because you'll get either diminishing returns or end up with something that's not as good. 

Interesting, what do you think about that idea? I disagree in terms of there are countless defensive tools available today that were not available when the Financial Crisis started in 2007 for example. Then fast forward to the crisis (small c for this one) for bonds with duration starting in late 2021. If the multi-decade, one way trade in bonds had ended in 2010 instead of 2021, there would have been far fewer fixed income substitutes to use instead of TLT and AGG. 

From my time at Fisher in 2002, they used the term capital markets technology which is what we're talking about. Buffer funds (no matter what anyone thinks of them) are an innovation, a new form of portfolio technology. When I bought RYMFX in 2007, it was literally the only managed futures fund. How often to I mention client/personal holding BTAL? BTAL didn't start until 2012. A few days ago we quoted Shana Sissel from Banrion saying that BTAL and managed futures are the most important diversifiers. 

All of this innovation has meant needing to sell less for defense than I did in 2007/2008. In terms of process evolving, I would rather offset downside with diversifiers than just straight up sell. It's much easier to get it wrong by reducing exposure selling down equities versus adding more negatively correlated 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.

Philosophy From Marshall Mathers

Let's start with this graphic from Gallup;

The trend probably isn't surprising, we are more divided and dysfunctional than we've ever been or certainly more divided and dysfunctional than we've been in a very long time. There are problems for which there is no visibility for solutions. I'm not sure solutions are even being worked on. This sentiment is a big driver for my harping the need to solve our own problems. 

Look, if you had one shot or one opportunity to seize everything you ever wanted in one moment, would you capture it or just let it slip? 

You probably recognize that from Lose Yourself by Eminem. This is our shot, our opportunity, we have to fix our own problems to get the most from our time here. To me, this means minimizing wasted time, worrying over things beyond our control, being unhealthy, sitting in rush hour traffic, really this is about living life on my own terms. So ok, if you agree with the polling in the graphic from the top down, that doesn't mean your life needs to follow that trajectory. Not following that trajectory may mean making a conscious decision, that "nope, that is not how I am going to spend my time." 

One way to waste time, is worrying to the point of panic over an investment portfolio which of course is a problem we focus on here. The stock market is going to go up long term whether you worry or not so might as well stop worrying. This is something that can be dialed in to avoid ever panicking. A validly constructed portfolio, combined with an adequate savings rate and avoiding panic will get the job done. That has nothing to do with beating the market. This puts an emphasis on constructing a portfolio that will allow you to not panic during events where others are panicking. 

Here's a fantastic passage from Steve Sears in Barron's;

While taking no action is always an option for true long-term investors, many others feel they must be in perpetual motion. This reflects how brokerage firms make clients feel with their marketing. Other people are under dire financial pressure and feel they must invest to offset expenses.

Whatever your motivation, let this column remind you of the importance of having a plan to handle volatility. You don't want to panic out of, or greed into, positions. You want to have a plan, and you want to be disciplined. If you do that, volatility becomes an important tool that helps, rather than harms, your interests.

Something else important will happen, too. You will develop a deeper understanding of how markets function, of normal and abnormal investor behavior, and you will arm yourself with a decision-making framework that is so critical to living a successful life—in and out of the markets.

The way we handle volatility is to build in things that pretty reliably smooth out normal equity volatility. I keep some things in place perpetually because "risk happens fast" and I also don't want clients to be overly leveraged to my reading every event correctly. Keeping BTAL and a couple of others means the portfolio is already at least somewhat prepared in case risk happens fast. If I can do a little more to spare some downside, great but I would count on nailing every single adverse event correctly.

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.

Problems That Will Never Be Solved

Yahoo hit on a subject that has been happening more frequently lately and that we looked at just once, the extent to which increases in Medicare more than offset the COLA bump to Social Security. As a made up example, maybe the COLA for Social Security is $50/mo but costs for the various Medicares go up by $70/mo.

The way things have gone, there is visibility in subsequent years for this to become a bigger issue meaning that in my example of a $50 COLA, Medicare goes up by $80 in the next year and then $90 the year after. 

My own take is that Obamacare accelerated the implosion of the healthcare system and we've made no progress in all these years to actually fix it. When Obamacare was first rolling out, one of the big arguments against it was that what they really wanted was single payer like other countries. Regardless of whether you think that would be a good thing or a bad thing, it is now so fouled up that single payer might be the only option. 

I don't know whether there is any will amongst politicians or voters (in terms of majorities) for such a thing and I don't know how I feel about it, I am simply saying we may have painted ourselves into a corner on the issue. 

The article said that premiums plus out of pocket costs total 1/3 of Social Security income and 1/4 of all income. “Retirees get this because they’re writing the checks now, but those nearing retirement need to realize that this is coming up,” That's a useful quote. Gen-X needs to start to understand this. 

What happens to your financial plan if half of your Social Security goes to Medicare premiums? Maybe that sounds ludicrous, but what if that happens? Is that a big problem, little problem or no problem? For readers of this blog, maybe this threatens margin of safety. If you're reading this, you probably have some sort of investment portfolio that will kick out an income stream plus whatever you are due to get from Social Security. 

Someone counting on $5000/mo in today's dollars from their portfolio and $4000/mo from SS might have to figure some things out if Social Security actually gets cut (don't forget about that threat) and then Medicare inflation continues at a higher rate than the SS COLA. Expecting $4000 might turn into getting only $2000. 

Here's a clip on Twitter of Dr Oz saying how much the country would be helped if people work one more year. The comments were generally pretty angry in terms of saying the middle and lower classes work longer to benefit the wealthy (read them yourself and see if you take a different message). The Yahoo article talked about delaying Social Security to get a bigger benefit which is always met with angry responses on these articles. 

What is your situation? How comfortable are you about your Plan A working out the way you want it to? Do you want or think you need a Plan B or Plan C? Forget the injustices and unfairness of the system because chances are we are all going to (hopefully) grow very old and then die without any of these problems ever having been fixed. 

So if the system won't get fixed, then we need to solve our own problem and we probably need to start working on that now if you haven't started already.

Part of the solution for everyone should be health. I try to avoid broad everyone should types of comments but is there anyone who thinks they should let their health go? People do let their health go of course but I don't think anyone would say that's a good idea. 

Copilot found studies that say the average 70 year old takes 4-5 concurrent prescriptions and goes to the doctor 4-7 times per year. A few good habits can push those numbers back to 80 or maybe even older which would make the decade of 70-80 much easier and much cheaper. 

Are you going to work? If yes, what will you do, stay at your job or find something new? Will you take Social Security early or will you wait? Do you have flexibility on spending needs/wants? Should you downsize? How much are you likely to have accumulated in your accounts when you retire? It that amount just enough, more than enough, not enough? 

Those are some of the questions to consider. This will not be a fun exercise. It involves exploring what maybe has gone wrong in the past or might go wrong in the future. Confronting those sort of things doesn't sound fun but is important. 

Let's finish on a lighter note, the documentary about the ABA called Soul Power came out on Thursday.

If you're a basketball fan and don't know about the ABA, I'm halfway through the second episode and it is fantastic. It's on Prime. Then after the documentary, get the book Loose Balls by Terry Pluto. The stories are fantastic. Marvin Barnes and the time machine, the Baltimore Claws, the story behind Julius Erving going to the Nets, the Lew Alcindor story, the Silna Brothers, Connie Hawkins, Darnell Hillman, I can't tell you how much fun this is. 

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.

Getting AI To Fall In Line

Barron's had a short profile on the recently listed iShares Systematic Alternatives Active ETF (IALT) which is similar compare to the longer tenured Blackrock Global Equity Market Neutral Fund (BDMIX), same managers running a slightly different strategy.

IALT is running three strategies, one is market neutral, the second is a "dynamic" macro strategy and the third is long only. The three will be combined such that the volatility will be in the 7-9% range. 

You can see the comparison. The idea with Portfolio 4 is that HFGM leverages up so I wanted to get a little closer to apples to apples with IALT. Portfolio 5 is a build it yourself version (maybe) but the volatility is way too high at 14% unless...

...you go further back, subbing in QGMIX for the newer HFGM. Portfolio 4 tries to tamp down the  volatility to be closer to BDMIX (cousin of IALT).

The performance of BDMIX is suspicious, trading flat and then turning up so markedly. Copilot said it was not a change in strategy, the fund started to do better because the various factors and markets it tracks began to do better so it is a function of patience paying off. 

The blend of momentum, macro and market neutral from Portfolios 2 and 3 in the longer backtest looks pretty good over the longer period but it differentiates from VBAIX by quite a bit. The extent to which that is a good thing versus a challenging thing is a toss up. In 2019 VBAIX outperformed by 850 basis points while in 2021 it outperformed by 700 basis points. That gets made up for and then some along the way but a point we've made before is that differentiation can be difficult emotionally which is worth remembering before building something that gets too far away from plain vanilla. 

Copilot likes the blend of those three funds, it notes the biggest risk would be some sort of event that simultaneously hurts risk assets like SPMO, "cross asset macro signals" impacting QGMIX and what it calls deal flow for ARBIX but when I said that ARBIX is more of a relative value strategy, Copilot softened up on that point. 

It said the biggest thing lacking from the portfolio was convexity which to me sounds like client personal holding BTAL. It didn't love BTAL, ranking it third best after managed futures and funds like SWAN which is mostly treasuries with long call options. SWAN should go down less than equities but get a kicker from the calls when equities rise. BTAL helps with SPMO but wouldn't protect against things going wrong with QGMIX and/or ARBIX.

Copilot then laid out ten macro strategies to stress test the portfolio but I am not confident it did it correctly. It included examples from 2017, 2018/19 and 2022 that could be bad for the portfolio but it did well in all of them. I pushed back on that and it rationalized that it was more of what could have gone wrong but didn't. 

This post has a couple of instances where AI gave an output that didn't quite seem to be correct. I've been asked questions about how to use AI and part of my opinion is that it is important to question outputs. It will go back and rethink answers which makes for more productive work. 

SPMO, QGMIX and ARBIX are all in my ownership universe. 

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.

Their Model, Our Funds

Alpha Architect Tweeted a link to its model portfolios. They are essentially the same batch of funds in different weightings depending on the asset allocation. So 90/10 has 35% in the S&P 500 while the 10/90 has about 4%. The models allocate between equities, alternatives and fixed income. There's no login required so I think sharing the details is ok.

Everything in the replication is in my ownership universe except SHRIX while CAOS from their model is a client holding. 

Their model has done very well. I think the only difference between it and the replication is QMOM and IMOM which target something called quantitative momentum. I added those two funds to the backtest to try to illustrate the challenges of holding them. The drawdowns tend to be pretty big and IMOM's outsized growth rate occurred just since November. A less impactful difference (probably) is the heavy exposure to SCHR which is a Schwab treasury ETF that has lagged our fixed income substitutes. 

I thought I wrote about this model before but couldn't find it in the archives, Copilot couldn't find it either.

If we replace HIDE in their model with Cambria Trinity which is think is similar in terms of a lot of trend and volatility, we can go back a few more years. 

Their model clearly outperforms VBAIX but with roughly the same volatility, probably because of QMOM and IMOM. I think their concept is well put together, this is just another example where we can learn from someone else's valid concept and marry it with our own ideas. 

I'll close with a quick bit of capital efficiency history.

Corey concedes that his mention of QDSIX might benefit from hindsight bias.

Portfolio 3 just kicks out GOVT and replaces it with QDSIX, so no leverage in the portfolio other than the extent that QDSIX might use leverage. QDSIX has done much better than GOVT with only slightly more volatility. We've mentioned QDSIX a few times over the years but Portfolio 5 better captures the approach we've blogged about here. 

Most of the people talking about capital efficiency and products providing access rely on plain vanilla bonds with duration but as we've seen countless times, a similar effect can be created without the complexity of the leverage or the volatility and unpredictability of the duration. 

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.

Scathing Rebuke Of Bitcoin

Larry Swedroe went off on Bitcoin. His substack post reads like he's angry. There are some points I agree with and some points I do not. 

The most recent decline, Larry says, proves that Bitcoin is not an inflation hedge in a time when reported price inflation is running above target and while gold is doing so well. 

The table only goes back five years and it takes in the recent crash through yesterday. Since Bitcoin's inception it has compounded at 137% versus 9.8% for gold and 14.8% for the S&P 500 while inflation has gone up by 2.58% annualized. 

There's nugget about Berkshire Hathaway that if it fell 99% it would still have outperformed the S&P 500 since Warren Buffett took over. Applying a similar thought to the price of Bitcoin, I asked Copilot how far would it have to fall in order to have merely doubled the rate of inflation since its (Bitcoin's) inception. Copilot said Bitcoin started at a nickel and that if the price fell to ten cents, "yes ten cents," it would still have doubled the rate of inflation. Based on the testfol.io data to Bitcoin's inception, that tracks but let's assume Copilot is off by a magnitude of 1000, it could drop to $100 and still be far ahead of inflation. 

Point conceded that holding it since inception is not realistic but I believe the five year table is realistic. 

Larry says it's not a haven. I can probably get on board with that because it certainly is not reliable. In 2022, testfol.io has inflation running at 7.04% and Bitcoin up 57% that year. The next year, inflation clocked in at 6.46% while Bitcoin fell 63%. The latest decline doesn't prove anything in terms of it being an inflation hedge. A four month spell doesn't prove or disprove anything. What if four months from now Bitcoin is at $130,000? 

He's correct about the relative lack of history. Fifteen years is not nothing but pretty much is nothing compared to gold. He also talks about the touts constantly reinventing the narrative which they do, I think implying charlatanism. I don't know how you observe Michael Saylor and not conclude he's a charlatan. All of the negatives can be true but it still can protect against inflation. Is the current decline in Bitcoin much different from gold's decline starting in late 2012 when GLD fell from $170 down to $106, 39 months later?

Inflation compounded at just 78 basis points in that period while gold negatively compounded at 13%. How about the period from August 2020 to October 2023? Inflation ran at 5.61% annualized while gold negatively compounded at 2.86%.

I agree with Larry on most of his points but not the big point. For my money, Bitcoin has never been anything but asymmetric opportunity but it clearly has protected against inflation even if it never does so again and four bad months proves absolutely nothing (repeated for emphasis). 

A pivot to a very academic article from the ReturnStacked guys taking the other side from me about adding duration to a portfolio. The conclusions rely on how things should work in a manner that I am not comfortable doing. It starts out acknowledging that in the current "flat term structure" it is "tempting to see duration as uncompensated risk." We've obviously been using that phrase for quite a while. 

This is rebutted by saying "misses a crucial point: bond yields act like gravity for long-run returns" and then that idea is defined in detail. "As yields rise, they drag present returns down but simultaneously lift forward-looking expectations. In many ways, all changing yields really do is push and pull returns across time." Cool if you agree and it is academically correct but I think of that as being pretty oblivious to having money already exposed if yields continue to rise. If you buy a ten year bond yielding 4% and then prevailing rates move up to 5%, the price of the bond will drop about 9%. For a 20 year bond, it will drop about 14%. 

There was then a long discourse about the role of inflation expectations in bond pricing. Academically important but how wrong did that turn out to be from the late 2010's on? 

The paper delved into the folly of trying to predict what interest rates will do. Agreed. But back to the idea of adequate compensation for the risk taken. Believing that 4% is not adequate for ten years is not an attempt to predict interest rates. I have no idea if ten year yields will ever get to a point where the compensation is adequate but 4% is not for me. If that is adequate for you, then you should take it. 

Reading through, there is a tremendous reliance on bond markets doing what they should as I would phrase it which is not a bet I would make with my money or client money. 

I'll close this out with the paper's shift to implying that bonds are the only diversifier versus equities. They obviously don't believe that but the paper took a very binary approach, bonds or nothing to diversify. They say there is a need for different return streams which yes, we have found many to blog about and that I use for clients with volatility profiles that I think people want from bonds as well as yields (in some cases) and total returns (in other cases). 

I've been using bond substitutes for a very long time which does not make the process infallible but long term readers have seen the thought process come together and then get implemented. There's probably not much of an academic rebuttal to what ReturnStacked is arguing but I've been at the very least, grossly underweight duration for 20 years, avoiding it entirely along the way. Twenty years is a long time in relation to a normal retirement span and even a normal career span for a portfolio manager. 

Yes there are certain functions and attributes bonds should provide but I would not tunnel vision on how things are supposed to work. 

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.

Stop Fidgeting

We had a structure fire this afternoon, right after the market closed so this post will be very short. Not much drama in the picture, the fire was contained to the chimney and was knocked down very quickly.

But I do have an analogy between fire trucks and managing an investment portfolio.

The red fire truck is just over eight feet wide, accounting for the mirrors, it is between nine and half feet and ten feet wide. The door right behind it is 12 feet wide. Once you line the truck up correctly, you can back right on in very easily. 

Someone new tried to back it in the other day after our regular training and was fidgeting with steering wheel so much that they were way off center, making putting the truck away much harder than it needed to be. 

Once you line up your portfolio correctly, it will get you where you need to be. Constantly fidgeting with the holdings, trying to optimize for the thing that just happened will make participating in the market much harder than it needs to be. 

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.