"You Can Only Hedge Against Known Risks"

The title of this post is a quote by JP Morgan strategist David Kelly from this morning on Bloomberg. I don't think he's right. Much of my process specifically targets hedging the unknown. We talk all the time about client/personal holding BTAL being pretty reliable (not infallible) at going up when stocks go down. Whatever the reason causing stocks to drop, the Covid Crash, 2022, the Tariff Panic, BTAL has been reliable in this context.

TAIL and VIXM have also tended to go up when stocks go down, regardless of the reason of why stocks are going down.

You can build this yourself to see but the three different blends drawdown less than straight equity exposure pretty much every time. 

I hovered on the 2022 low because 2022 was a pretty bad year for TAIL but that combo still was down less than the S&P 500.

Copilot weighed in, that "Kelly’s statement is directionally true in a classical risk‑management sense, but it’s not literally true once you introduce convexity, volatility‑linked hedges, and regime‑adaptive hedging tools like BTAL, TAIL, VIXM, VIXY, or managed futures. These instruments do hedge risks that are not explicitly “known” in advance — but they hedge them probabilistically, not specifically."

So essentially the difference is the text book versus real world. The emphasis in that passage is Copilot's, not mine. 

That brings to a post from AQR about the mistake they see people making when they realize that bonds don't work for diversification in the manner that they used to so they are pivoting to exposures that actually have a higher correlation to equities than bonds, they are essentially adding more more equity beta to their portfolios, AQR says.

As I read the paper I started to think about barbelling a full equity exposure into a narrower slice of the portfolio which could come from leverage, using products that target more volatility or even with higher beta exposures in unlevered exposures. 

Portfolio 4 is just SPY and the other three, the rest is cash. HFEQ targets twice the volatility, XLK is technology and simply has a higher beta and SSO is a levered 2x fund. The chart is so short because of HFEQ which was pretty close to the other three until it had a great month in February. I am guessing it pulled away from the others for being long a lot less tech. You can see the 70% XLK portfolio pull away to the downside as the private credit whatever we're calling it started to unfold. 

Here's a longer term look at XLK that dials in a 74% weighting, 26% in cash, as being very close to 100% SPY. 

The year by year results though show the two taking much different paths to the same result. So the flaw in this backtest is optimizing for XLK's lifetime instead of trying to dial in the year by year. I couldn't get the data Copilot needed to optimize minimal year by year dispersion. 

Here's a similar backtest with 50% SSO/50% cash going back to SSO's inception 19 years ago.

They're not that far off from each other. Is that close enough? Maybe, maybe not, it depends on the user. I don't think any other fund compared like this with the 2x version of itself plus cash would be anywhere near as close but as we've been saying for a very long time, SSO stays pretty close over longer periods most of the time.

I wasn't able to find an alt to sub in for the cash to get a better return than SSO plus cash but I think that is because there were far fewer funds from 20 years ago versus today. It was a little easier to find some outperformance with newer funds and much shorter backtests. 

There is something to this theory, it can work longer term. More realistically, 50% into a 2x levered fund is not the answer but maybe a smaller slice worked into a portfolio can be an answer. 

Lastly, the Calamos L/S Equity & Dynamic Income Trust (CPZ), a closed end fund, popped up on my radar. It yields about 12%, it's leveraged up about 27%, it has done a good job in terms of not returning capital to make it's distribution, only six monthly payments included any ROC since it started paying out in December 2019 according to CEFconnect. It gets its yield from the leverage and then investing in preferred stocks and fixed income, it is not a derivative income fund. The long/short book is neutral biased so more like a market neutral or absolute return strategy. 

CPZ first started trading at $20. On a price basis it is not keeping up with its distribution which should not be a huge surprise. The total return has compounded at 3.94%. The huge rally in 2021 appears to be from the fund zooming up to trade at a pretty large premium to its NAV. Copilot posited that the run up in 2021 was more about top down yield chasing than anything to do with the fund. 

While I am not interested in using CPZ, I am intrigued by the l/s and yield combo. There will be a better mousetrap in this space.

This whole post was an exercise in sifting. I've used that word before. I spend a lot of time looking for ways to improve the portfolio which includes looking at strategies or funds that won't be able to do that. 

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.

Wildland Fire Training

Today we had the annual Basin Ops Drill which is the annual, interagency training exercise with live fire. It's always a ton of fun.

Our new Type 6 engine  (brush truck)

A small fire that we made quick work of getting a line around it and then putting it out.

Me in the white helmet.

I dig the color of the BLM trucks but they aren't called BLM anymore.

The S&P Is Turning Into A Tech Fund

A few quick hits today.

We've looked once or twice at the Simplify Multi QIS Alternative ETF (QIS). The fact sheet boasts exposure to 25+ quantitative investment strategies. Here's the chart.

The yield is modest so the total return is slightly better but the fund is down a lot. The holdings are pretty opaque unless you know what FOXBP1TRS and SBABOATRS are. Some of the holdings are intuitive but more power to you if you can figure out how the strategies are actually positioned. The easy conclusion is that the fund is too complex. 

Last August I questioned how the fund was still open. This post had a little color about QIS being intended as a fixed income sort of proxy like 60% equities, 20% bonds and 20% QIS. Based on the fund's result, there's no point in backtesting it. When QIS first started trading, I backtested the concept with other funds which looked good, I said the concept seems valid but the fund somehow hasn't lived up to the concept.

This next chart compares YieldMax Tesla (TSLY) which is a covered call strategy and the GraniteShares Tesla Yield BOOST (TSYY) which is a put selling strategy.

The chart is price only. Anyone taking out the income, that's a lot of bleed. I've said several times that I think selling puts is a better way to go, note that TSYY is selling puts on a levered Tesla single stock ETF, but there is no way the price of a fund is going to keep up with this kind of "yield."

Tell your friends how these work so they don't spend 85% of their principal in 16 months.

Bloomberg says that SpaceX is targeting a $2 trillion valuation for its IPO which might be coming as soon as June. Anthropic is currently valued at $380 billion and OpenAI is at $820 billion and both intend to IPO at some point. At $2 trillion, SpaceX looks like it would be the sixth largest in the S&P 500, Open AI at $800 billion would be tenth or 11th with Anthropic further down the list obviously.

SpaceX would probably go into the industrial sector but still be pretty techish. I'd expect Anthropic and OpenAI to end up in the tech sector. All three stand to make the S&P 500 even more tech/communications centric than it already is from it's current 43% (down from 45%) up closer to 50%.

That will potentially be a lot of volatility, really a lot. Ways to address that include building the portfolio at the sector level, adding and small doses of negatively correlated holdings or using different factors that underweight tech. 

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.

Mind Boggling

Barron's wrote about increasing financing costs for BDCs and other segments of the private credit space. BDC stands for business development company. There are many publicly traded BDCs as well as private pools. Barron's mentioned Van Eck BDC ETF (BIZD) which is down 12% YTD. It yields a little over 9% and oddly, the BIZD web page reports an expense ratio above 12%. I don't know what the story is unless it's acquired fund fees but that 12% number is repeated in multiple spots. The fund is a good source of names though, the holdings, for anyone so interested in learning about BDCs. 

Let's start with the price only return of some historically yieldy but volatile pockets of the market.

If you don't remember Nordic American Tanker (NAT), it was a huge favorite of the all dividends all the time crowd at Seeking Alpha. Annaly Mortgage (NLY) is similarly loved by that crowd. Here are the total return numbers for those four.

The yields and the negative compounding is far less dramatic than what we see now with the crazy and even not so crazy high yielding derivative income funds. Still though, it is difficult to compound positively when getting a high yield and taking it all out. Deciding to implement that strategy, negatively compounding, isn't as bad as implementing it and not realizing it will probably compound negatively. I see touts on Twitter occasionally boasting about how they have portfolios that "yield" 20-40%. They don't. 

At the other end of the yield spectrum, Morningstar lamented the historically low yield of for domestic stocks at less than 1.2% versus 2.6% for foreign equities. Dividends aren't necessarily the tax-friendliest way to go but many people do like yield. Tweaking a concept we've looked at before of allocating a small slice to a crazy high yielder, I built out the following.

SPY plus SSO equals 100% S&P 500 subject to any volatility drag from SSO. NFLY could be thought of as an overlay of Netflix' volatility. We use NFLY for blogging purposes because it avoids crazy CEO risk and it is not the most volatile name in the YieldMax universe. SSO historically tracks closely to 2x the S&P 500 far more often than not. 

ACWX, a different index than what Morningstar cited, has yielded a little over 3% while the portfolio we built is just ahead of the 2.6% that Morningstar referred to. If a catastrophe befell NFLY it would be a very minor setback for the portfolio. SSO could malfunction of course but the fund has been around since 2006 and the worst relative year in a down year appears to be 2018 when it was down 14.62% while SPY was down 4.56%. In 2007, it was up 1.04% versus a gain of 5.14% for SPY which is a different kind of bad outcome.   

There is of course an element of unknown outcomes in terms of what any crazy high yielder will distribute but someone wanting to seek/target a little higher yield could add just a little bit to the crazy high yielding sleeve without the risk that the whole portfolio looks like TSLY which is down 85% on a price basis since its late 2022 inception. 

Not investing related but the NY Post reported about an ongoing fraud ring that allegedly poisoned Mt Everest hikers to get them to pay to be airlifted off the mountain. Included was this picture of a hikers' procession. It is a mind boggling photo. 

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 War Portfolio

Some interesting stuff today.

First is that London firm Marex issued a structured note that is very Kalsi-like. It will pay a 7% coupon if Nvidia is still the largest company in the world when the note matures after its one year term. If it is not the largest company, then the principle comes back with no sort of interest or return. 

Marex has more of these planned. Polymarket is pricing an 80% probability that Nvidia will still be the largest company a year from now so Marex can hedge based on that market. The article reads like this was more of bespoke placement but there is a very high likelihood that these will proliferate. Other than credit risk of the issuer, an above market return with the reasonable risk being that investors just breakeven is compelling. If this takes off the way I think it can, there will be quite a few issuers. 

Ethan Powell from the Brookmont Catastrophic Bond ETF (ILS) sat for a short interview with Reuters. Powell said that AI will play an increasing role in how issuers price risk. Also, the industry will grow to take in different types of perils beyond the typical weather related perils. 

Cat bonds are a terrific example of a part of the market where the results are consistently fantastic but where the allocation should be kept small or at least small-ish. The space yields 8-12% in a 4% world so that means there is risk there. It's not crazy risk and I think the risks involved are relatively easy to understand but if there is ever some sort of dreadful hurricane season then the bonds will pay to the insurers at the expense of bond holders. It would need to be truly dreadful but not impossible. When we play around with model portfolios, the amount I often put into cat bonds is far more than I use in real life. Likewise with the new product mentioned above. If they ever become retail accessible, keep the allocation small, maybe a little bigger if someone creates an ETF that holds a bunch of them.

Man Financial posted a paper this week called Apocalypse Now? The objective was to war-proof an investment portfolio. It's a wordy article with a good bit of data but the following was as specific as it got, it didn't provide weightings.

However they blend all that together, they backtested this result;

I guess it is a war hedge but it seems more like an all weather portfolio. I took a run at trying to build this using their inputs as follows.

SDS is 2x short the S&P 500.

The result had a higher CAGR and a little more volatility. A little more to BTAL and a little less to SPMO/SPHQ would dial that in if someone wanted. It's obviously very resilient in down markets and it's interesting that it was never the best performer during an up year for broad markets. The growth rate is very 60/40-like yet it holds no bonds. That's a pretty big building block here, the idea that there are many ways to offset normal equity volatility without using bonds. 

BTAL, VIXM and SDS have down years most of the time and BNO is down about 1/3 of the time and very volatile. That's a lot of holdings, four out of nine, that all spend a lot of time going down. It's hard to argue with the bottom line result but that could be tough to look at. 

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. 

Blue Owl Keeps Going Down

Let's continue with some followups to previous posts but also some broad market dynamics too. 

It keeps getting worse for Blue Owl (OWL). The other alt investment firms appear to be in sideways patterns after enduring what thus far have been less severe declines. There is an ETF that tracks these with symbol AAUM which is down 22% YTD.

Obviously the private asset space was showing signs of trouble before the war in Iran started. It's not clear to me that the war is making it worse is making in terms of demand for withdrawals from funds that don't offer daily liquidity. That seems like a market event versus the war being a geopolitical event.

We've looked at these stocks before. They are obvious proxies for the space. We isolated that during the good times and it is apparent during the rough times too. Similar to tech, the group tends to outperform on the way up and go down more on the way down. There's a sort of capital efficient or barbell aspect to it. A small allocation to something with these attributes when sized correctly can provide a return similar to a full allocation to equities but the drawback is periods like now. Forgetting Blue Owl, a 25% drop from a smaller equity allocation might be emotionally difficult to endure when the broad market is down much less. Sized correctly, the dollar impact would be the same but still tough to endure. 

Here are four more portfolios we built for random blog posts that I wanted to circle back to.

The first one is the Cockroach Portfolio that we've looked at many times, this latest version was November of 2025 where the title of the post was I Cracked The Cockroach! Maybe! I can't find a link to the post about the portfolio I labeled Asness Factor Blend but it was in the folder on my computer where I keep all these portfolios we blog about. No dice on the HEQT/Managed Futures post either. Here's the link to the post about the 75/50 portfolio. 

All the portfolios did much better than 60/40 in 2022 which was due to avoiding duration and adding managed futures. I don't feel that I am cherry picking because I actually did that for clients that year. The Asness Factor portfolio is of course quite the standout. I'm not sure why I used the AQR Market Neutral (QMNIX) back then because despite the name it has had some monster up years that may not repeatable. If they are repeatable then I wouldn't think of it as market neutral despite the name.

Redoing that portfolio to use more of a real market neutral/absolute return proxy, the results are still compelling versus VBAIX and more inline with the others. 

The 75/50 portfolio was too conservative, it captured less than 75% of the upside of the S&P 500, more like half and it went down a lot less than half the S&P. It did quite a better than VBAIX but again, that is attributable to avoiding duration and owning managed futures. While I think duration will be a bad place to be going forward, if that sentiment ends up being incorrect then these portfolios will probably look a lot like VBAIX, not outperform. 

ReturnStacked updated its model portfolios and I wanted to review a couple of them, Structural Alpha Growth which is sort of an 80/20 and Structural Alpha Moderate which is like 60/40. What I did for these is build them exactly as the appear on the website. The models are leveraged using their capital efficient funds, the models leverage up 25-30%. The way they do this is if they allocate 10% to RSST in the model, that adds 10% of domestic equities and 10% of managed futures. It's probably not ok to share the holding and weightings as they posted them, you can create a userid and password and access them yourself. 

The unleveraged versions are mathematically true to the originals, just scaled down.

My version of their 80/20;

And 60/40;

It is very rare if ever where I see the leveraged products actually making it better. Part of it might be their willingness to have AGG-like bond exposure but that doesn't account for all of it. 

The concept is clearly valid so maybe the fund category needs to evolve more. I do think the idea of doubling up the volatility which only a couple of funds do at this point (meaning they target volatility not twice the daily return), could be a better path to capital efficiency via exchange traded products. 

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. 

Let Opportunity Find You

Barron's posted another Gen-X isn't ready/is worried about retirement article. The concerns are medical expenses and not knowing how to create an income stream from their portfolio. That second one overlaps with insecurities about having enough money. Part of the dialogue was some survey that said a lot of us, I am older Gen-X, have pension envy like we're not getting pensions but we wish we were. 

Kind of a weird thing lately or maybe a weird sensation but I've been seeing where quite a few guys I know from high school and college are retiring. It's weird because it seems so foreign to me. It probably shouldn't because of how many people from the fire service I know here who have retired at much younger ages than what my friends are doing. One fire buddy at a city department down in the Phoenix area who is 38 now, started when he was 22 and he is absolutely going to retire once he has 20 years in. 

The 38 year old doesn't want to stop working, he would just move onto the next thing with his pension as a financial base. 

The health care cost is something we talk about all time. In our department we have four firefighters who are very active in the department at ages 66-70. All four passed the arduous pack test (3 miles, 45 pound pack, 45 minutes or less). Two of them I know take no prescriptions, one I think does and the fourth, I am not sure. 

Grok says that only 11.4% of Americans 65 and older take no prescription meds. In our department, the number is at least 50%, maybe 75%. Someone who is 65 or older and passing the pack test must be committed to their fitness in order to pass it. There is of course a connection to not needing prescription meds and the lifestyle choices related to exercise that they've made. I realize my sample size is very small but it's what I've got and it corroborates a lot of what I try learn about health, wellness and vigorous exercise. 

If my colleagues aren't taking meds, that means they aren't paying for meds (yes that is a stupidly obvious comment) but it addresses one of the big concerns that my cohort has. 

Older Gen-x still has time to figure out the financial stuff. Someone who is 57 should be able to see how much they have accumulated and assess whether they are behind, right on pace or ahead of where they should be. If they aren't sure, AI can help them figure it out if they don't want to work with an advisor. 

If this 57 year old is way behind, they have plenty of time to play some sort of long game to cultivate an income stream from a post retirement career. Six or seven years for example is a pretty good runway to work on cultivating an income from some enjoyable endeavor, 63 or 64 is a young retiree. 

My own preference is to have as much optionality as possible. Something dramatic would have to happen at this point for me to start getting serious about wildland fire assignments away from home. Other things developed favorably and so there isn't going to be time for the fire stuff but I just had a conversation today about "keeping my task book open" just to have the optionality because I don't know, maybe something drastic will occur. 

I got a couple of assignments to get my feet wet and of course the opportunity came from my very long term commitment to the volunteer fire department. My gig with the Del E Webb Foundation also came from my volunteer fire department involvement. I don't think most people need to volunteer for twenty plus years to have something pay off but the point is converting something you love into an opportunity in case you need it. Maybe I would change that to talk about opportunity finding you but you have to be out there for that to happen. 

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.