Rough & Rougher

Wall Street got kicked in the stomach on Friday, or maybe a little further south than that. Stocks were down a lot. Big tech was down a lot more. Bonds with duration were down a good bit, not a ton. Managed futures were mostly lower. Gold was also down a lot. Broad commodities were down a little less than gold. Bitcoin spent a little time below $60,000 for the first time in ages.

Client/personal holding BTAL was up a lot....yay? I'm glad it "worked" today but if BTAL is your best performer then things are going badly. REITs, staples, some financials and healthcare were generally green. 

Are markets worried that rates won't get cut anytime soon with the jobs data the most recent nail in that coffin, or are markets worried that there is no end in sight to the war, is it the excesses related to capex spending/debt issuance/equity issuance in the AI/data center theme, were we simply overdue for a pullback or was it something else? Yes.

Today is a great microcosm though for a lot of the portfolio construction theory we play around with here. Let's detour for a moment to what today's blog post was originally going to be about. Finomial Tweeted out a thread of a portfolio review for a capital efficient strategy that looks a lot like something we would work on here.

Here's the backtest result versus 80% equity/20% bonds (Finomial chose that benchmark).

The portfolio that Finomial posted has certainly been more volatile but hard to argue with the longer term result. It's easy to see that volatility on display in both the Tariff Panic last year and the broad reaction to starting the war with Iran. In the Tariff Panic it was down 18% versus 13.8% for 80/20. That is probably attributable to managed futures getting hit very hard during that event and the portfolio has close to 18% in managed futures. 

The point isn't to pick on the portfolio, it is to understand what the experience of riding through with some huge number in managed futures, or gold, or broad commodities or something else would actually feel like and how difficult it might be emotionally.

This sort of day would be challenging for anyone who is heavy in any of these.

We've talked about 5% in TECL which is not heavy IMO but 20% in one day is not nothing. We've never talked about SOXL which is 3x semiconductors. If it is as simple as looking at RSST and subtracting SPY's result to see how their managed futures sleeve did, then it was the biggest decliner of the ones I follow. I threw in HFGM because it targets twice the volatility of global macro. 

What would that table look like if this was the start of a meaningful move lower? Do you remember that fast panic that happened at the end of 2018? Most clients don't but in that fast event but TECL fell by 60%. Sixty percent in an event that many people don't remember. From July 2024 into early August, so just one month, RSST fell by 18%. I remember one or two very bad days in the first week of August but I'm not sure why RSST would have fallen that much but at the same time VBAIX was only down 4%. RSST came back obviously without issue but how difficult would it have been for someone who was heavy in RSST going down 18% in a down 4% world?

This is a difference between theory expressed in backtests versus actually enduring a market event. How did the portfolio that Finomial analyzed do today? Down 3.41%. That's probably not a number that will induce a poor decision but what about a week from now if equities continue lower and the things under the hood of managed futures continue to run counter to the recent trend (managed futures is likely long equities, long gold and long other commodities)?

I hope I am consistent in saying not to go too heavy into any of these diversifiers but if you are going to put 20% into something like managed futures or gold, I would spend time envisioning what it would really feel like when things take a meaningfully negative turn. 

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. 

Solving Problems

The picture is of the engineer's compartment from Walker Fire's brush truck (type 6 engine).

The hardware pictured is a reducer, an inch and half double female, 2.5 inch double male and a 2.5 inch double female and you can see there is other items in the bin. These tools allow us to change hose size, make connections to truck outlets and even pair up incompatible thread types (there are two types of thread for some reason). The way I have been describing this to new firefighters has always been to say there is no problem that can't be solved out of this compartment, you just need to know what you're looking for. 

The ETF universe is of course similar. I mentioned taking in a new client for my subadvisor relationship early this week. The client came in with 55% in tech with heavy weightings in many of the names that are front and center for the AI/semiconductor mania that we are currently in.

I am hesitant to use the word bubble, I think mania might be a better word. Semantics aside, there is clearly an excess in this theme. Tech/communications is too big to zero out but I've been saying here for ages that I have been underweight. As of right now, tech plus communications adds up to 50% of the S&P 500. History has not been kind to sectors that get above 30%. Obviously there is no way to know when or even if there will be a consequence but the sign of excess is clear. No exposure is a non starter, repeated for emphasis but underweighting is viable.

For this new client, I sold a lot of the smaller names and shaved down the exposure to the major names he held. My usual tech holding for clients is broad based sector ETF that is heavy in many of the names I was keeping for him albeit in smaller percentages than what we walked in the door with. Loading back up on a sector fund that was top heavy in all the same names made no sense and would have left him very exposed to the same stocks that would be in real trouble if there is ever a consequence to the current AI/semiconductor excess. 

While 50% in tech plus communications is a non-starter for me, 10-12% is too light so into the engineers compartment for the Invesco Equal Weight Tech ETF (RSPT). Instead of 45% in semiconductors it has about 25% and obviously there are no holdings in the low double digits or high single digits. Weaving RSPT in with the holdings we kept/reduced allowed for dialing in some pretty precise percentages to bring him inline with other clients. 

Sort of related with the tech excess, back in May I swapped out market cap weighted ETFs for the few clients who had one for the momentum/quality/value combo we discussed a while back. The momentum ETF is kind of like MCW on steroids and the other two differentiate considerably from MCW and I think the three will combine to give a better result with a less total tech exposure than MCW.

The takeaway here is a point we make regularly which is I am not trying to predict anything, I am trying to avoid, or in this case underweight and obvious build up of risk. 

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. 

Autocallable Theory

Larry Swedroe did a deep dive on the Calamos US Equity Autocallable Income ETF (CAIE). The basic idea with the fund is that it owns a series of structured notes that mature each week. The fund targets a 14% distribution. The fund would run into serious problems if it's reference index fell 40%. The reference index is similar to the S&P 500. CAIE has sensitivity to the reference index on the way down but in its one test so far, it captured a lot less of the reference index' recovery which is to be expected based on the structure of autocallables. 

You might look at that and decide right away these aren't for you (XV, SBAR and ACYN are also autocallable funds) but there has been no malfunction with them. 

Some points made by Swedroe; first is that 90% of the distribution is a return of capital. Yes it is a very high percentage. He warns that this has the effect of lowering your cost basis in a taxable account so that when/if you sell the cost basis might be nothing, so you'd owe a capital gains tax. Yes but that would be less than the tax on a true dividend. 

Larry then talks about gains being capped as I noted above which is correct. Don't buy this looking for an equity proxy on the upside. Larry notes the 40% threshold for problems starting, that is called a barrier, and yes a decline that big would be bad for the fund but it would be bad for everything. Don't buy this looking for downside protection. He further equates it to being short a put option which gives some good context for how it should behave.

The next issue is the counter party risk with JP Morgan and the cost embedded to pay the counter party. This isn't quite the threat he makes it out to be, if you don't already know this, don't bet too much of your portfolio on the credit worthiness of one bank. The odds of things ending badly for JP Morgan are quite low but sized correctly the actual risk is minimal.

He picks at the complexity and opacity. Yes, they are both, moreso complex than opaque. The strategy is learnable, I'd argue that these funds are less complex than the typical macro fund. Yes it is not cheap too. This is not a three basis point index fund. 

Larry says the NAV must erode and you can see that with SBAR and XV but it hasn't happened yet with CAIE. It probably will erode but I am always leery of using the word must. 

The article finished with checklist of sorts, what you want versus what you get. Once you understand what the fund does you realize that if you want what Larry says you want, you should find a different strategy.

As a matter of curiosity, I'm always going to want to try to find a plausible use for these flawed products, products riddled with drawbacks anyway. I continue to believe there is a use case for things like autocallables and crazy high yielders as part of bridge to the next financial milestone like taking Social Security or taking RMDs with the expectation that any basket of these will deplete toward zero.

The question/tradeoff goes something like this. An investor is 62 and wants to live off a $200,000 bucket of money until they take SS at their preferred age of 68. The income need from this piece of money is $40,000/yr for six years. If they leave the $200,000 in cash they can get five years, plus a couple of months from the interest. How likely would it be to squeeze out a sixth year or even a 7th thanks to the large distributions (ROC and all).

Using a combo of autocallables, not the craziest high yielding YieldMax funds (think Microsoft and Google, not Tesla and Microstrategy), cat bonds, then a sleeve in something like the BCKT or LDDR ETF which both offer depletion strategies and I threw in WTPI which is a pretty high, not crazy high, yielding  ETF that sells put options and doesn't really erode, it doesn't go up on a price basis but it hasn't eroded. There are countless closed end funds that could be part of the discussion to. 

With enough holdings, like maybe a dozen, any sort of issuer risk, strategy risk or idiosyncratic risk could be reasonably diversified.

Back to our $200,000 example, taking $40,000/yr from a basket of these would leave $57,000 left over after six years and probably get the investor through a 7th year with just a little leftover.

If it works out that a lot or most of the "yield" is ROC, that would not count toward modified adjusted income which could keep someone below the income threshold for health insurance from the marketplace to be subsidized which would be helpful until Medicare starts.

There are several grains of salt to take here related to reduced distributions and an extended downturn in markets but to the extent we do some work here on portfolio theory, this one is pretty far out there but still interesting. 

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. 

Is It Ok To Die Rich?

There are a lot of personal finance topics where people draw a wide range of conclusions. Social Security is a great example, take it early take it late? There are plenty of good arguments on both sides of that debate. Another important one even if it engenders a little less passion is how to spend/withdraw from accounts to fund retirement. 

Someone who is too frugal might die with a lot of money leftover unspent, they didn't live their fullest life possible the argument would go. The other side of that is people who spend a lot, too much really and maybe they turn out ok financially or maybe they run out of money with the ultimate goal being that the check to the undertaker bounces (very old joke). 

Bill Bernstein and Edward McQuarrie wrote about this, breaking people down into two groups. One is the richest person in the graveyard which is a phrase attributed to Steve Jobs. The argument against spending too little is that it is not a "rational" choice. The other group is people who are willing to live with the fear of running out of money. I'd use the word stress more than fear; willing to live with the stress they might run out of money. 

Any advisory practice will have both types of clients with most of them in the middle I believe, taking a relatively safe to slightly generous amount out. 

The Bernstein/McQuarrie article gives permission to be the richest person in the graveyard, RPIG as they call it. I can understand the idea of dying with $5 million in the bank after years of living a $100,000 lifestyle would cause some form of regret but if we assume there aren't too many of those out there, Bernstein/McQuarrie validate the utility that could go with having a relatively high number in the bank.

I've made this same point slightly differently, I usually say there is value in never having to worry about money. That doesn't have to mean having millions in the bank. Being able to cover your desired, retirement lifestyle with Social Security and maybe one or two other income streams but not needing your $800,000-$1.2 million IRA seems like a pretty comfortable spot to be in. 

It's very important to figure out what type you are in this context. Although I am very unlikely to accumulate anywhere near $5 million in today's dollars, I am closer to to being RPIG. Not worrying about money is very high on my priority list, it goes hand in hand with independence which is the real priority for me. It's not about being rich, it's about being comfortable; financially independent. 

I'm not saying anyone else should view this the way I do, I am saying figure out where you are on this issue so you're not sitting on a mountain of money at 93 if that would cause regret or so you don't spend 1/4 of your life stressing every up and down of the stock market if that would make your life less enjoyable. 

A quick pivot to something that isn't completely true but might be in the future. I saw a post on one of the socials that Nvidia will pay people $2000/mo to house/host a small server. The idea is that with all the pushback against big data centers, servers about the size of a generator could help alleviate the problem. My first reaction was it can't be true. 

So there's something to it, still in a trial phase. They aren't paying $2000/mo but covering internet and utility bills and providing battery backup for your house? There might be 100 reasons not do this if it ever goes mainstream, I don't know, but it would be worth learning about if it ever was available in your area. What if it does evolve into Nvdia, or some other company, paying you for this setup? Getting even $1000/mo toward a $5000 or $6000 lifestyle seems like a lot, especially given how under saved we collectively are for retirement. 

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. 

No ETFs?

I spent the afternoon working on a project with an advisor I subadvise for so I wasn't able to make time for a real blog post but I have what I think is an interesting observation. His practice is primarily professional athletes and he has a new client he's bringing over from JP Morgan.

The interesting observation is that for the 80 or so equity holdings, they didn't use any JP Morgan ETFs. JP Morgan has developed into strong second tier if not higher ETF provider and this account didn't own any.

Maybe I shouldn't be surprised but I am. 

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. 

Too Good To Be True?

Over the years there have been a handful of reader comments that really stuck with me. One reader joked about the best way to die as being shot by a jealous husband at 110 years old, I told my dad that one and he really had a good laugh. Recently I referenced the reader who put 1/4 of his portfolio into Pozen 20 years ago and then there was a bad FDA ruling. 

Another one came at some point in the Financial Crisis when a reader said to just put it all in Hussman and forget about it. 

I'm not sure which Hussman fund he was talking about so I included both. Hussman is usually bearish and does a great job framing out the prevailing bear case but I think he leans very hard into protecting against the bearish conclusions he draws in a manner that seems to ignore the reality of markets going up the majority of the time. Although stale info, as of last fall HSTRX had 68% in cash versus an average of 6% for the conservative allocation strategy. The period studied is the decade after the reader left the comment, HSTRX has done a little better since, compounding at 7.09%. HSGFX is still compounding negatively. 

There's a reasonable argument for Hussman being a bear market manager but "putting it all into" one strategy that is this defensive is not the answer. 

All of that is a preamble to the iShares Systematic Alternatives Active ETF (IALT) which is a multi strategy fund that includes equity, credit and macro. Based on the description is seems AQR-like.

I wouldn't expect it to have a similar growth rate to equities over a longer period of time but the first six months of trading catches my attention. Just put it all into IALT and forget about it? I doubt it's a magic bullet for equity like growth on the upside but absolute return behavior in drawdowns but who knows?

There's no easy way to assess the holdings as presented on the website so with an assist from Copilot;

That still might not be easy to dissect but it helps at least a little. If it is difficult to understand the holdings then it will also be difficult to break down what is driving results so back to Copilot. IALT has benefitted from carry, look at RSSY for confirmation of how well carry has done lately. Before this latest run doing well, RSSY went down 30%, this happened before IALT started trading so carry can be difficult to hold.

There is an equity market neutral component to IALT's portfolio which is similar to BDMIX, you can look at that fund to get a longer term perspective. In the last few years BDMIX has been on an absolute tear but before that, it had mid-single digit returns more inline with what you might expect from market neutral.

Copilot also gave credit to macro trend and relative value so there is some overlap with managed futures which has also been doing well.

All of these doing well at the same time is not an expectation that anyone should have. It might happen 1/4 of the time Copilot said. If you think about these different sleeves being quadrant-ish like the Permanent Portfolio (completely different types of quadrants), how often do all four work at the same time? The entire premise of the Permanent Portfolio is that no matter what, at least one will be working which implies there will always be at least one that isn't working. "IALT is not designed to produce high, smooth returns. It is designed to produce diversified, low‑beta, multi‑premia returns."

Copilot did say it makes sense as a diversifier for being slightly positive in an equity crash, a little better than that if inflation spikes taking commodities higher, it will probably go down in a credit crisis and it would probably do poorly if yields spike.

Take those expectations though with a grain of salt. IALT is an active fund and might be able to manage around some of that. Or not. There's no way to know. 

IALT would be a complementary alt to managed futures, merger arb, certain long/short equity and macro. It would be duplicative with alternative risk premia (AQR has at least one of those) and carry. I pushed back on managed futures and global macro not being duplicative but it came down to nuance. If you're curious you can go into the AI of your choice to get an explanation or maybe you'd get a completely different answer.

Turning this into a discussion of ways to use AI, this exchange mostly replaces talking to a sales guy. On the plus side for AI, I got un-salesy answers, the AI is able to look under the hood in away I could not and answer questions that I doubt a sales guy could. AI also has knowledge/understanding of other strategies. On the negative side, Copilot could be wrong about multiple things. If I was actually interested in IALT with its complexity, I would probably repeat this exercise with Claude to compare and contrast and then still talk to a sales guy. A call with a sales guy would probably be more productive after having checked in with AI.

I'll track this one. We might now know what the good times look like for IALT, it would be nice to see what the bad times look like or if it can somehow defy the occasional painful mean reversion that hits some of the strategies it uses. 

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. 

If Inflation Doesn't Get You, Forced Retirement Will

Price inflation, not poor returns, is the biggest threat to 4% rule for a sustainable withdrawal rate in retirement. We mentioned that a couple weeks ago when we looked at a podcast that William Bengen sat for with Morningstar. The point came up again in a Barron's article about five tips for retirees to protect themselves from price inflation. 

Here's what Barron's suggested;

• Delay Social Security as long as possible
• Own stocks
• TIPS not bonds
• Make sure cash is actually earning interest
• Own precious metals

The point about Social Security seemed a little odd because no matter when you take it, you get the annual cost of living increase. At this point, hopefully everyone has thought about the tradeoff of getting less money every month by taking it sooner and more money every month taking later but no matter what, you get the COLA.

Equity exposure is of course where a lot of growth will come from. Sizing the exposure correctly isn't always easy but for most people, something in the neighborhood of "normal" like 40-60% will be a good number even if not an optimal number. TIPS versus bonds, if you agree with the premise, own individual TIPS not TIPS funds.

The fourth one is sneaky. At Schwab and Fidelity, there are accounts where the default for uninvested cash pays essentially nothing. You need to proactively buy a money market that has a competitive yield. Schwab says they don't hide this fact but I am not sure they promote it either. The practice seems insidious to me but nonetheless, you need to be on top of this point. 

Precious metals, especially gold, should protect against inflation but gold can be a tough hold with any sort of large weighting. Gold can go a long time doing relatively little versus equities. My preference is think of gold as a diversifier, weighted accordingly as opposed to a core holding on par with equities in the manner that the Permanent Portfolio allocates to gold. 

A building block of understanding that gets some attention but not enough is the extent to which overall expenses can go down when you're older, retired or not. First is not having to save for retirement after you retire. If there is no earned income, then you're not paying 7.5% of income (W2 workers) to Social security. Can you synch up the final mortgage payment to coincide with retiring? Toyotas can pretty reliably last for 20 years so no car payments for a long time. Health insurance versus Medicare is trickier because of the amount that employers contribute to the cost. The thresholds for IRMAA are very high and just about anyone subject to IRMAA is spending a smaller percentage of their income on their coverage.

For most people, their incomes go down when they retire, so then do their taxes. If someone is paying more in taxes after they retire then they are either making more money (seems like a positive outcome) or they lose their spouse which is of course a negative outcome. 

Per a Google search, the median percentage of take home pay that people pay for their mortgage is 30-43%. That's kind of a wide range but it's a big number either way. For cars it's 15-20%. Using Gemini and Grok to try to assess health insurance versus Medicare, it might go up a little for W2 workers but go down for self employed people. Actual expenses could be a very different story. On the Google page with the search results was an ad for an article by Investopedia that said retirees spend $1 for every $6 they earn. That's more than paying Medicare, that would also include out of pocket for doctor visits and prescriptions.

People don't believe this so ok but the types of chronic maladies that people take prescriptions for can be reversed by cutting carb consumption and lifting weights. I can't say it is universally true but is often the case and there is no downside to eating less sugar and getting in better physical condition from exercising. It's a legitimate dollars and cents aspect that ties in with this conversation. 

What about discretionary spending? What does your typical month look like? Despite the word discretionary, how much of your discretionary spending could you actually cut back on if you had to? We don't eat out a ton, so hard for me to say but is it easy for couples to eat out less? Are there things you buy on some regular interval that may not be truly essential but still somewhat necessary that would be difficult to cut back on? My wife gave me a good example, ladies who get Botox. She does not, no judgment from me but how well would "honey, you need to cut back on the Botox" go in households where Botox treatments are a regular thing? What about a house cleaner? 

So maybe with some looking ahead, these sorts of expense reductions without sacrificing discretionary spending that isn't so discretionary can be put in place to help start retirement with a much lower base which would minimize the impact of inflation. If a $7000 monthly nut can be cut in half because there is no mortgage payment or car payments, then the impact of inflation on a $3500 monthly nut would be much easier to absorb. 

All of the above was about coinciding with a planned retirement date. What about those who end up having to retire sooner than they expect? Here's another Barron's article where the latest data says more than 40% of Americans retire sooner than they planned. That seems like a huge number but whether it is accurate or not we know it to be the case for many people. 

Someone who is 55 today, thinking they want to retire in 8-10 years should probably do what they can to move up the timetable on all the things we're talking about today. Health insurance stands to be a big threat but with incomes below $84,000 for a couple, plans on the government plan are very (fully?) subsidized. 

The solutions to planning and threats to whatever plans we make are up to us to figure out for ourselves. I find it easier to work on creating income streams to add to potential portfolio income I might take and Social Security when the time comes. I have general preferences of continuing to work, delaying SS until 70 or close to it and having a couple of small income streams for an extra margin of safety. I find it interesting that my preferences aren't really changing. I think these ideas go back to before I was 40, I'm 60 now. There's nothing truly enlightening there, just interesting.

I try to be consistent in not saying everyone should about when to take SS or the rest of it, I'm more trying to convey my thought process that gets me to a conclusion that is right for me. Certainly, everyone should understand tradeoffs but once you do, take the appropriate path for your circumstance and beliefs.

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.