Sectorology

A couple of weeks ago, we discussed how the S&P 500 was turning into a tech fund. Barron's took up the conversation this weekend and included a list of ETFs that should help reduce tech exposure. 

If you're interested, you can look through and decide for yourself if any of them are worth owning.

The message from from my post was that if you build a portfolio at the sector level, it is easy to just reduce the exposure you have to tech/communications and you can also layer in small exposures to negatively correlated strategies to reduce the portfolio's beta. A little more nuanced would be to use SPXT which is the S&P 500 excluding technology. Using SPXT would allow for very precisely dialing the tech exposure. As you can see from the top holdings though, there is plenty of what I would call tech-like beta.

Back in March we looked at a broad based index strategy from Research Affiliates that combines quality, value and momentum. We built the idea by equal weighting SPHQ, SCHD and SPMO. Owning those three instead of market cap weighted S&P 500 would combine to a 33% weighting to tech plus communications versus 45% for the S&P 500. QVML is an ETF that combines those three factors but its weighting to tech plus communications is just over 44%. 

If a portfolio went 2/3 domestic with SPHQ, SCHD and SPMO and 1/3 foreign (20% ACWX 13% EMXC), then the total to tech plus communications would add come down slightly to 32%. ACWX is light on tech, EMXC is heavy in tech from Taiwan Semi, Samsung and SK Hynix. 

Yahoo had a weak retirement article that included a discussion about how to allocate to bonds and the idea that Social Security is essentially an annuity. 

One guy was all over the comments banging the dividend zealot drum. This comment captures where he is coming from.

If one invest in quality stock for dividend then the dividend income will always be there and the stock will go up in the long run. If your interested in dividend why would one care about stock going down? Quality company will always recover, dividend will at least be the same or more throughout the recession and recovery !

There is a stock market graveyard full of the exact type of companies he is talking about that were once quality stocks with "good" dividends. Washington Mutual, General Motors, JC Penny, Walgreens and countless others I am forgetting. 

Who knows what he actually means but the comment reads like he is oblivious to the possibility that down the road some quality stock with a "good" dividend that he cares about could disappear. The strategy he favors is of course valid but guy, great companies disappear. How about Bethlehem Steel and most of the rest of the steel industry?

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.

Bloomberg Bashes Buffers

Nir Kaissar wrote an article at Bloomberg titled Buffer ETFs Are Insurance You're Better Off Without. His general argument echoed the one made by AQR in 2025 which generally says you'd be better off just lowering your equity exposure. Eric Crittenden from StandPoint has made the point that they turn the risk/reward upside down, there is more potential risk than reward. Plain vanilla buffer funds cap the upside and then protect against the first X% down like maybe the first 9% down or the first 15% down. After that, investors are subject to whatever losses the underlying incurs in the period defined like maybe one year or one calendar quarter. If the stock market falls 30% in a year then a buffer fund that protects the first 9% down, would end up dropping 21%....essentially. 

Since then, there have been quite a few products that adjust or try to improve on that very general framework. I don't do a whole lot of work to study them because I believe the arguments are more right than they are wrong but I wouldn't dismiss buffer funds entirely. BALT is in my ownership universe for clients. 

First, I agree, don't count on them to ever deliver equity market returns. If there is some suite of them intended to capture the stock market's upside that I am missing, please leave a comment with some symbols. 

BUFR and BALT have both been around for a while. BUFR protects the first 10% down for one year. It owns a ladder of different buffer funds and the cap ranges from 13-17%. You can see from the chart that it has a bit of equity sensitivity. At its low in 2022, BUFR was down 13.52% versus 24% for SPY. It has compounded at 9.42% versus 12.26% for SPY with a vol level of 10.63% versus 17.30% for SPY. It's not better than SPY and it is not worse than SPY because it is not SPY it seeks a different outcome.

BALT protects the first 20% down and resets quarterly. The upside cap is also reset quarterly and is usually just above 2%. It uses the S&P 500 as a reference but it is not intended to function as an equity proxy. The symbol BALT is a play on bond-alternative. Copilot says that in the last 50 years there have only been three calendar quarters where the S&P 500 fell 20 or more percent; the 1987 crash, 2008 and the Covid Crash. In each instance the drop for the respective quarters was 20-23%.

You'd be better off reducing your equity exposure. 

I tried to create that effect here. Portfolio 2 tries to combine SPY and SHY to get the same growth rate as BUFR and Portfolio 4 combines the two to get the same result as BALT. The growth rates are close but Portfolio 2 is somewhat more volatile than BUFR and Portfolio 4 has twice the vol as BALT.

To get Portfolio 2 down to the same volatility has BUFR, the weighting to SPY would be 62% but the growth rate of Portfolio 2 would lag BUFR by 92 BPs annually. To get Portfolio 4 down to the same volatility as BALT, the weighting to SPY would be 16% but the growth rate of Portfolio 4 would lag BALT by 230 BPs annually. 

I don't use BUFR and don't plan on doing so, I personally wouldn't think of it as an equity proxy but maybe some folks might. BALT is definitely not an equity proxy. Both have risks and quirks that need to be understood and if necessary mitigated, but that is no different than any other non-equity thing you could possibly buy. 

What does some buffer fund you might be looking at reliably do? Is there a need or room in your portfolio for the result that this buffer fund you're looking at reliably gives? That would be the first question I would address. Then, how does it deliver this result? Is there a basis to believe it can continue to deliver that result that you have at least some interest in? Then, if you look under the hood and don't like the details, don't buy it. For me, BALT has a differentiated, fixed income-like return stream without taking interest rate risk and less volatility than many fixed income proxies. 

The return profile, combined with a volatility of 3.35% makes sense to me as a fixed income substitute. It is not equities, repeated for emphasis. Keep in mind that the weighting is small, 5-10% of the fixed income sleeve so pretty small. If something breaks, the impact on the portfolio would be minimal.

Kaissar also talked negatively about bond buffer ETFs. I didn't know there was such a thing. I'll just take a quick look at the Innovator 20+ Year Treasury Bond Buffer ETF (TBJL). The fund references TLT, protects the first 9% down and the upside cap for the year ending June 30 is 48%. Hedging bonds is cheaper than hedging equities. 

To even consider TBJL, you'd have to be ok with TLT-like exposure which I am not. TBJL seems to have done what it is supposed to. In a long, shallow downtrend for TLT, TBJL is down less. I threw TLTW which sells covered calls on TLT into the chart for a little more context. Anyone who understood TBJL and has been holding it is probably satisfied with the relative result. Part of Kaissar's argument against funds like TBJL is that there are no distributions. That's true, the fund owns an options combo, not 20+ year bonds. 

From the top down, long term bonds are just the wrong part of the market, full stop. So anything that references the wrong part of the market is a pass for me. Mark Baker says that when you're on the wrong train, every stop is the wrong stop. I think that applies to TLT, TBJL and TLTW. At some higher yield than we have today, I'd be interested in probably no further out than ten years. If there is ever a yield that adequately compensates for holding that long, I'd probably just rather have the simple yield.

One quick snippet. Calamos launched another autocallable ETF with symbol CAGE. The info page says the "weighted average coupon" is 29.16%. Meb Faber found this;

I don't know the story yet but on the surface, this is drifting into crazy high yielder territory.

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 Emotional Cost Of Being Different

Let's check in on convertible bonds.

CANQ uses leverage to own a portfolio of fixed income securities with an overlay of equity options that is intended to create the effect of owning convertible bonds. You can see CANQ yields about 5.5%. CHI is a closed end fund that kicks off a lot of yield but the drawdowns in the price only version are brutal. CHI is less a proxy for converts than it is a yield machine. It fell 30% during the taper tantrum and last month it was down twice as much as the S&P 500. In the period studied, the State Street Convertible Bond ETF (CWB) is up 18% with less volatility than the S&P 500. Despite being "bonds," convertibles have a lot of equity beta. This was just a follow up on CANQ, it's done well. A fine return and the drawdowns haven't been catastrophic. 

The other day we had some fun looking at the cost of being different and some work from ReturnStacked. They came up with an allocation that they thought was optimal and actually useable after first discussing an allocation that is optimal but not really useable. 

I simulated Optimal Stack w/NTSX from the above linked post using SPY and AGG to go back just a little further. The red line portfolio is similar to optimal but not useable from the ReturnStacked paper in that no one would actually want to use it. It would be too difficult emotionally for many people.

It is a steady eddy but it lags almost constantly. It has been effective though at chopping off the left tail. Negative, outlying returns are referred to as being left tail on a bell curve, the portfolio we're talking about chops off the left tail because it looks different and the cost of being different is that it lags to the upside. Over the long term, I am quite certain it will provide an adequate long term result but I am also confident it would lag up markets most of the time. 

Simplify tweeted about its SBAR ETF and referred to it as an autocallable. XV which is another high yielding fund from Simplify is also an autocallable strategy. In case I am not the last to know, there you go. CAIE was generally considered the first autocallable ETF, I thought it was anyway, but SBAR and XV are a little older. Copilot said that the funds have always been autocallables but now the category/strategy is more recognizable so Simplify is referring to them as such.

A high yield with no NAV erosion is a good outcome but the market hasn't really been tested since SBAR and XV started trading. There is some sensitivity to declines as seen in March of this year. I threw BALT in there because there is some overlap of risk. I didn't throw in any crazy high yielders which has more risk overlap but as we know from many other posts, there has been plenty of NAV erosion with those products. I'd like to see how these weather a serious decline and then how quickly they can recover but a small allocation, like 5% of the fixed income sleeve, isn't reckless. 

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.

Bloomberg's Definitive Retirement Guide

Bloomberg posted a robust retirement guide based on how many years you have until you plan to retire, gift link. 

First, here is a table that came up several times, adjusted throughout the article based on age. 

Those numbers either resonate and/or seem realistic or they don't but whatever you end up with is your reality and what you need to work with. If someone at 65 making $125,000 has $700,000, $2 million or is right on this table at $1.14 million, their accumulated piece of money can kick off 4-5% pretty sustainably. If you're 65 and 4-5% of your accumulated piece of money is $40,000-$50,000, that is your math. For better or for worse, that is your sustainable number. Is your number enough? If not, what are you going to do? You need to figure something out.

Obviously, social security will be part of the equation. Will you have other income streams? Do you need other income streams? If so, have you figured out where those will come from? 

Maybe one partner will get $3000/mo from Social Security and the other will get $2000/mo. Then maybe a safe withdrawal rate from retirement accounts adds up to $45/yr ($3750/mo). Figuring out $8750/mo was easy enough. What are expected expenses This work is a little trickier because forgetting things as you sit down in front of a spreadsheet is probably going to happen. One that would be easy to forget for my wife and me is road maintenance. We have to maintain our road. To just have it graded is $600-$700 but could be a good bit more if we need to buy material (dirt/composite). I'm sure everyone has their version of getting the road graded. 

Ok so regular monthly expenses, other non-monthly regular expenses (car insurance as an example), what is your health situation and how expensive is that, are there other regular lifestyle expenses that are more discretionary in nature like paying for a hobby, how about more expensive fun like trips and what about emergencies? Did I leave anything out? Probably, but you get the idea. 

What's that all add up to? How does that compare to your SS plus reliable portfolio income, the $8750 we used above? Sticking with the $8750, framing, if all those expenses above add up to $8500, ok, that's good but there's not much room for error. That doesn't mean you should turn your life inside out but it is important to understand how slim of a difference that is. 

There was a snippet in the article about figuring out how to build some flexibility into your portfolio withdrawal strategy, I think that is a good idea. There was more time spent on addressing sequence of return risk. My answer is sell some holdings while times are good, maybe put enough aside to cover expenses equal to the number of months of the average bear market. That used to be 18-30 months but it has been awhile since we had one that long. 

Maintaining good health was in the 10 Years To Go section, invest in your health it said. Pushups are a good indicator of health. Here's a table from AI that I am going to bring up at fire training on Saturday.

How old are you? How many can you do? If you can do a good number based on the table, then chances are you'd do well with other physical indicators like grip strength or dead hang. 

Of course the Fidelity study about lifetime healthcare costs was brought up. Staying fit to the point of very few or no prescriptions will bring the Fidelity number down considerably. The guy in our fire department who is 70 and can still pass the arduous pack test takes no prescriptions. If he lives to 100, even if he needs to start any prescriptions soon, he's made it a decent chunk of the way through his retirement without spending money on prescriptions. 

It is not too late to get diet and exercise dialed in. The chronic maladies that many people take medication for can be reversed (google it). Fix your blood sugar, lose the gut and build some muscle mass. 

A 57 year old was cited talking about the high cost of health insurance being an obstacle to her retiring early. Yes, it might be very expensive, but maybe not. Low income levels are still very cheap through the government market place. We looked at this earlier, right around $84,000 of income for a couple is the Mendoza line for it being very cheap versus being expensive. Google Mendoza line if you're not a baseball fan.

In 2025 and this year, $709/mo covers both of us. Yes, it is crappy insurance, I think we'd have to pay $15,000 out of pocket if something awful happened, but we are very fortunate to not need anything but annual physicals. 

The article talked kind of a lot about 85% of Social Security being taxable above a certain income level. Realistically, if you're interested enough in investing to read a blog like this, you should plan on your Social Security being taxable. This will be unpopular but I wouldn't spend the time calculating the 15% you won't owe taxes on. Let your accountant's software just tell you how much to pay (estimated) every quarter. You're not not planning, you're letting your accountant figure it out for you. 

Not enough time, in my opinion, was devoted to figuring out what you will do with your time. We probably all know retirees who seem to be very busy all the time and others who sit in their Lazy Boy yelling at their television or maybe something else.

It's not for me to say what someone else should want to do, like yell at a cloud, but it is important to figure out ahead of time what your retirement looks like. 

A lot of this post is yet another reiteration of what we've been talking about for 20 years, literally. The overriding idea to all of this is that retirement is an equation that needs to be solved. The more time we all put into planning our idea of retirement, the more successful we will 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.

"The Cost Of Being Different"

Morningstar has an article up about the importance of diversification but warns about over diversifying. Here's the money quote from author Amy Arnott. "In my opinion, most investors need exposure to three core asset classes: US stocks, international stocks, and investment-grade bonds." She adds that some people might want TIPS exposure too. 

Over the long term, both portfolios (note I did not see suggested weightings beyond 60/40) compounded just fine at 7.17% and 7.59% respectively. Those numbers, combined with an adequate savings rate will get it done.

But neither version offers any real diversification. They track the market, they are the market, they don't differentiate from the market at all. Put differently, what is it the Morningstar thinks is being diversified away? If someone just went 100% SPY at the start of this back test, they'd have had larger drawdowns every time on the way to a higher growth rate; no differentiation, just bigger swings. 

The notion of overdiversification is worth raising though. I think we explore that here by try to keep things simple, relatively simple or in trying to allocate more heavily to simplicity versus complexity. A lot of the portfolio construction ideas we pull in to blog about flirt with overdiversification. The Cockroach Portfolio might be a tad busy, so too is some of the work the ReturnStacked guys do with their model portfolios and there are others. But we can learn from all of them. 

That brings us to a paper from ReturnStacked titled "What Is The Optimal Stack?" The focus seems to be trying to create a portfolio that has the same volatility as plain vanilla 60/40 but improve on every other metric. The real answer from them was a very levered up split with 24% to equities, 71% to bonds, 7% gold, 55% merger arb and 39% managed futures. They had a funny bit about how unworkable that is in real life. I spent some time trying to recreate it such that it had a volatility the same as 60/40 but I couldn't get there. 

Corey Hoffstein Tweeted out this image that was not in the paper. I think it was an output from their new optimizer tool.

I tried several different things with this blend.

Note that you have to be comfortable with AGG-like exposure to actually implement any of these. I am not but I am pretty sure the ReturnStacked guys are. 

All three are better in terms of CAGR and the volatility of Portfolios 1 and 3 are almost identical to VBAIX but I think the way in which they all went down much less in 2022 adds a favorable skew. In the other drawdowns, they don't look much different. 

If you really want to diversify, they say there will be an "expected cost of being different" which is a great line. Just about every backtest you can run that has a large weighting to managed futures looks fantastic but the "cost of being different" is that there can be long periods where it underperforms. Ditto gold. Do you like merger arb? I certainly do but a very strong year for merger arb might be up 7% which looks paltry compared to a strong year for equities. 

We could create more differentiation by including exposure to negatively correlated assets that are more immediately reactive to market declines as we've done in dozens of posts. Using those types of strategies pretty reliably creates a much smoother long term result but can be difficult in shorter periods, that is the "cost of being different," frustration in the short term. 

When you really invest the time to understand how something like managed futures actually works, it becomes much easier to hold on during that frustration. 

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 An Inheritance? Don't Mess It Up

A couple of retirement related items. First up is a thin article about the psychology that might go with inheriting money. There can be feelings of "guilt and grief." My tiny sample size with clients, there's never been guilt but grief happens, a loved one just died. 

I'm about to talk out of both sides of my mouth but while relying on getting an inheritance is a bad idea, you do need to know if it is likely and need to do some planning. If you're going to inherit some or all of one of your parents' IRA accounts, you need to plan for taking all the money out over ten years. I can't believe they made that a requirement but they did. 

You have the option of waiting until year ten to get the max tax deferred growth but if it is a lot of money, then you might be paying tax at 37% in ten years when you take it out. If you're still working ten years from now and inherit a $400,000 IRA today and want to wait to take it out in ten years, that $400,000 invested in VBAIX might double. $400,000 into VBAIX in 2016 is worth $992,000 now. That's an enormous tax bill. Maybe for someone, this scenario is their best outcome, or not, but there is no reason not to think this through well ahead of time. 

Taking out $40,000/yr in this scenario might end up in a similar net dollar amount but paying less taxes, sort of a wash? Putting $400,000 into VBAIX in this scenario ten years ago, letting it sit untouched until April 13, 2022, it would have grown to $701,000. Then there's four years to take out the money, maybe $175,000 per year...sort of. The money not yet taken out is still growing. Pretend they just took the last $175,000 out today, there would still be $109,000 from price appreciation of VBAIX to take out in addition to this year's $175,000 and now the account is depleted. 

Figure these people earn $150,000, then add the $175,000 they take from the inherited IRA. They are in the 24% bracket with an effective rate of 19.3%. In the last year, adding the final $109,000, they do get up into the 32% bracket on a few of their dollars earned but the calculator at taxact.com has the effective tax rate at 20.89%.

One way they might be able to cut their tax bill is contributing to their 401k. Having earned income makes you eligible to contribute and the limits of course can be quite high. If you've been living on $150,000 and get an extra $175,000 from an inherited IRA then there's a good chance you can fully fund your 401k...assuming you're eligible of course. 

Does this seem like a lot of detail? We didn't even get into inheriting money not in an IRA, like maybe from the sale of a house or maybe the parents just had their money in taxable accounts. 

I realize don't rely on it but plan for it is contradictory but I think it is prudent to understand the probabilities of your situation and do a little planning. Then if it actually happens, do some serious planning. Use AI if you want, it's probably a good idea, if nothing else, maybe AI helps you avoid a really bad strategy even if it doesn't get you to an optimal strategy. 

The other article was about whether or not to pay off your mortgage from Barron's. In terms of the math, paying off a mortgage with a low rate is not optimal. Again, that is just the math and ignores the emotional value of being mortgage free. The idea is that it is reasonable to think you'd get a better return investing the money than paying off a 3% or 4% mortgage. That idea is less compelling though with a mortgage at 6% or higher. 

VBAIX failed to return above 4% about 1/3 of the time, eight out of 25 years, since it started trading. We are all going to draw our own conclusion about what makes sense in this regard. The mortgage on our Airbnb rental is 3.5% and we are not paying it off early. It's a 15 year that will be paid off in 2032. The mortgage we just took out for the house in Tucson is 6.375% and we plan to pay that down very aggressively over the next four years +/- by not contributing to my 401k. If we get it paid off when I am 64 or 65 and I am still working (that is the plan), then we can resume 401k contributions. 

Being able to do this is a function of the optionality I think my wife and I created for ourselves when we were younger.

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 Two Best Defensive Strategies?

A research paper from Robeco concluded that the two best defensive strategies are trend and Defensive Absolute Return (DAR) which is a fairly new idea built of course on plenty of data, 220 year's worth from the Robeco paper. We've looked at trend a couple of hundred times so let's focus on DAR, what is it?

Basically, DAR goes short the equity factors with the highest correlation to a 60/40 portfolio and long the equity factors with the lowest correlation to a 60/40 portfolio all as an overlay. We'll use VBAIX as a proxy for 60/40.

I asked Grok to layout whatever factors it could find and build a table of correlations.

From that list, the obvious observation is that all the correlations seem pretty close to each other. Is this going to work? Here's how I tested DAR; with leverage, no leverage and then the Research Affiliates idea of blending momentum, quality and value in a long only fashion which seems like an effective way to use factors. 

The time period is short to easier observe the 2020 Pandemic Crash and the 2022 bear market. 

The drawdown screen grab hovers over the 2022 low and you can see both versions of DAR helped a little. At the low of the Pandemic Crash, the unlevered DAR was the best of the bunch, about 500 basis points better than VBAIX.

There might be something to it but I don't think it lends itself at this point being easily implemented with ETFs. VettaFi doesn't show any inverse factor funds available so anyone wanting to actually do this would need to be able to short the factor ETFs. This would also require monitoring correlations of the various factors as there can be volatility in correlations. The current level from Portfoliovisualizer is much different than what Grok found.

A quick pivot to an old article from the Washington Post about lifting weights, especially for your legs. There was a study cited in the article that said the heavier you lift, the more benefit you get. Well, no kidding. Heavy is relative. Whatever your max is, per the article, do 70-85% of that max for reps. It doesn't matter whether your max for something is 20 pounds or 200 pounds, you should be able to do reps at 70-85% of that number. 

"Leg strength is a critical indicator of wider health and mobility among older people." They also mentioned staving off frailty. Leg strength helps with balance and mobility which leads to much better outcomes in terms of quality of life and independence. 

Do more squats and learn about creatine. Squats doesn't have to mean what is probably the most common version, the back squat. This guy's form is an injury waiting to happen.

I typically do a set of landmine squats

A set of leg press

And then maybe goblet squat, Bulgarian split squat or something that kind of looks like this but with a kettlebell where I only hinge at the knees; it blasts my quads;

Deadlifts and farmers carry also hit the legs. Jump rope, which I do a ton of, helps with calves and more importantly with balance. 

These exercises don't threaten injury the way that back squats do. As far as creatine, I take it. All I am saying here though is to learn about it and decide for yourself. Don't just take it because I said so, as far as that goes I am just some guy on the internet. The way it works is it retains more water in the muscles which expands the surface space of the muscles which in turn makes you stronger and a little bigger. You will not get too big. It is important to drink water regularly. I know one downside is that some people feel bloated, my wife gets that sensation from creatine so she doesn't take it. 

Doing more squats might be the best defensive strategy for aging successfully. 

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.