Portfolio Efficiency

Peter Hecht from AQR sat for the Flirting With Models podcast. Hecht is the Co Head Of Portfolio Solutions at AQR and the conversation was about portable alpha/capital efficiency/return stacking. 

We've looked at this quite a few times. It's a fascinating concept, I track my interest back to my time at Fisher Investments in 2002 (repeat story coming). A couple of the smarter guys there geeked out over the fact that going short Nikkei futures with 2% of your portfolio and nothing else equaled the return of the S&P 500. It doesn't matter whether they were correct, I don't know, but the idea was mind blowing. 

Then something similar from before the GFC when Nassim Taleb talked about going all out for risk with 10% of the portfolio and then putting the other 90% in T-bills from around the world. The idea from Taleb was getting most of your return from a small slice of the portfolio while the vast majority of the assets are safe.

The word efficiency applies to both ideas. I think they both fit the bill of leveraging down as we've talked about it before. The history of portable alpha drew negative attention as fallout from the GFC when the common implementation was leveraging up equity exposure to buy more equities which ended very badly when the S&P cut in half. 

Today the conversation is about using leverage as a funding source for uncorrelated alternatives without selling stocks or bonds. Someone concerned about tracking error but wanting exposure to alternative strategies could leverage up to include something like managed futures. 10% into a levered fund like CTAP when combined with 50% SPY and 40% AGG would have 60% in equities (10% from CTAP and 50% from SPY), 10% in managed futures from CTAP and 40% in aggregate bonds from AGG. In this example, CTAP solves the "funding problem." Man Group has a similar fund and of course ReturnStacked's entire lineup is about solving funding problems. WisdomTree has also been a leader in the liquid, capitally efficient fund space. 

So there is bad leverage and good leverage. Bad means just adding equity beta on top of equity beta where good leverage is adding uncorrelated betas on top of equity beta as a means of adding uncorrelated alts or alts with low correlation. That is a takeaway from the podcast not me weighing in. 

One way to manage the leverage and keep it as good leverage is to just add up and net out the betas. Here's an example with SPY and client/personal holding BTAL.

So that's a good amount of leverage over a reasonably long period. You can see the betas are almost the identical with the 120/30 having a noticeably better growth rate. It's not a great example but it works...sort of. It is more volatile and there aren't any defensive attributes but the reliability of BTAL allowed for leveraging up. 

There was a lot of the podcast devoted to equity long/short. BTAL is an example of short biased long/short, there's also market neutral like merger arbitrage and long biased like QLEIX. If I understood correctly, using portable alpha (leverage) to add market neutral is the most common use of portable alpha that AQR sees but it's not necessarily the most effective use for portable alpha. Hecht thought that multi-strategy is the best way to go because it allows for easily diversifying your diversifiers. He added that if whatever multi-strat you're using isn't quite getting it done, increase the managed futures exposure. 

A quick sidebar, Hecht noted that over the long term, longer than any of the current mutual funds have been around, managed futures as pretty much equaled 60/40. Claude, is that right? The TLDR from Claude was the on a risk adjusted basis (not nominal returns) it's close but that the paths are wildly divergent. 

Peter and Corey talked about how to size a portable alpha strategy in client accounts and the answer boiled down to right up to the point that the advisor would panic. I've never heard an answer like that in any sort of investment related setting. It seems both very honest and flippant at the same time but I really got a kick out of it. 

The idea of "portfolio efficiency," pretty sure that is the term I used 20 years ago on the first iteration of my blog, plays a role in my portfolio process. It's about understanding where return is likely to come from among the holdings. In a normal bull market, more of the portfolio's growth will come from tech instead of staples or utilities for example. One aspect to how I use alts is that they dynamically protect more of the portfolio in a falling market which is a form of efficiency that helps pursue the goal of greatly reducing downside capture. 

I built out a capitally efficient model for this post that uses just a little leverage with an approach we haven't used before (I don't think). It is a variation on leveraging down. I am not a fan adding a lot of leverage.

WTLS is WisdomTree Efficient Long/Short US Equity Fund. It is 90% S&P 500 and 90% long biased equity long/short. QNZIX is 50% domestic equity and 50% managed futures. The others are one we regularly use for blogging purposes. The leverage of this mix is modest. The notional equity exposure is 53%. There's modest managed futures and the fixed income sleeve avoids duration. 

Portfolio 2 adds 5% BTAL and takes 5% away from BKLN. This adds a little negative convexity and slightly reduces credit risk if there is ever a credit event. 

The backtest is very short due to WTLS' inception. Most of the outperformance comes from going down a lot less when the Iran War started. SCHD has done much better than market cap weighting this year which has also helped. Copilot tried to backtest it (theoretical of course) and the version without BTAL would have been down 10% in 2022, maybe, and the version with BTAL would have been down 9.5%, maybe. I do believe the volatility numbers are little more useful than the CAGR numbers and the standard deviation is also quite a bit lower.

No portfolio can always be best and with a longer period to look at, that would be the case here but it does bring in attributes that I think are important for navigating a full stock market cycle.

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 AI Ready To Build Your Retirement Plan?

The Wall Street Journal looked at a few ways to tweak the 4% rule for retirement withdrawals. The article acknowledged that William Bengen has since dialed up the number to 4.7% but has said 5% is just fine. There was also a note about Morningstar adjusting the number every year based on some sort of assessment of current conditions. The last few years their estimate has been in the threes, proving too conservative as markets rocketed higher. 

WSJ's ideas included copying the RMD table (that's not how they described it), mapping out non-discretionary spending (medication and groceries for example) and discretionary spending (hobbies and travel). If someone is actually living on 4% and they can attribute 2.5% to non-discretionary then they'd be able to cut back on the discretionary spending when called for like in a serious drawdown. 

The comments are worth reading, there was a lot of sentiment that overlaps with what we've looked at before, notably that growth in the portfolio will account for inflation, also that the types of suggestions in the article overcomplicate the task. Our answer to overcomplication has always been to just take 1% out of your balance every quarter. Yes, it requires some flexibility but setting aside some number of months worth of expenses in cash can reduce the need for flexibility. 

A related idea we talk less about is the more likely scenario that people will have several different types of accounts; some combo of taxable accounts, traditional IRA, Roths and HSAs. In this scenario, it might make more sense to deplete an entire account and then move on to the next one. 

"The book" says to pull from those accounts in the order I put them in above but there are exceptions. The example I always use is buying a car. Assuming you don't want to go into debt for the car, If the car costs $40,000 but it is paid for from a traditional IRA, then accounting for the taxes, it will cost more like $50,000. Pay for the car from the Roth and it will cost $40,000. 

Lately, we've been talking about bridge strategies, depleting some piece of money over the course of a few years to get to some financial milestone like maybe starting Social Security or having to take RMDs. I've written more about this lately because I think it's how my wife and I will probably frame out our financial plan as we get older. 

I am hesitant to use the word retirement, I can't see choosing to give up my day job but as I get older, I should plan for my income from portfolio management to go down. Most clients are quite a bit older than me so there are some inevitabilities there. We have a pretty good income stream from our Airbnb rental but at some point we might want to dial that down to spend less time on it. Less time would mean less revenue. 

Over the next ten years, income from portfolio management plus the stipend from Del E. Webb plus the rental income should exceed our expenses. If everything goes as hoped for with Social Security then we'd both take it in nine years-10 months with the total covering our fixed expenses and then some. If it gets cut by 22% (low probability outcome but not something to ignore either) it wouldn't be a catastrophe but something we'd have to reckon with. 

Ten years from now, we might want to sell the rental cabin or sooner or maybe later but for now ten years makes sense to think about. The proceeds from the cabin could be a bridge to delaying RMDs (I mean spending the money, there's no avoiding taking them out of your IRA). We've talked about living in the rental for a couple of years to avoid paying the capital gains tax (I don't believe we'd get out of paying back the recapture). If something goes wrong, we could live there to meet the capital gains burden. 

If we did sell what is now the rental cabin, we'd still want to have Prescott house we live in and the Tucson house and split time between the two. Eventually we'd have to sell the Prescott house we now live in. If things go well then maybe that would be when I am 85-90? These proceeds could be a bridge until the end without ever relying on the IRA for covering expenses.

I asked Grok to age me 30 years, like when we might leave Prescott. That's not 90. It said it thinks I'm in my mid-40's to early 50's. I will take that, thankyouverymuch.

Why would I want to never rely on the IRA for expenses? Thinking about all this allowed me to identify a hot button for me which is if I ever need some sort of serious care, that I be able to receive that at home. My wife framed it a little differently, we have a casita at the Tucson house that some sort of care provider could live in which sounds good but would take work for find the right person for that. 

If you're still with me, I plugged this narrative, and strategy plus a few more details I'm not sharing here into Copilot to evaluate what I have in mind. There was a lot of back forth with Copilot. I found that letting it start very simply and then adding inputs to bring Copilot to a point where it understood our situation was the way to go. When I finally had all the inputs and details entered and felt like Copilot did understand, I asked it for a qualitative assessment of our plan. 

It gave feedback as a well as a simple list of the positives along with ideas of what the vulnerabilities might be. This was good, it was helpful. I then said to spreadsheet it out with base case and worst case scenarios, it also threw in a "conservative" case scenario and a summary.

The spreadsheet got a lot of things wrong. Really a lot. It assumed we sell the Prescott house that we live in when I turn 67, not much older. There were instances where it did assume account balances would compound and others where it didn't to that calculation. It omitted the Del E. Webb stipend for quite a few years, it ignored my base case for taking SS at 70 in all three assumptions. 

I did not spend the time trying to correct the spreadsheet errors. That the spreadsheet was so far off surprised me because the qualitative feedback was correct. 

Having a qualitative exchange was helpful for me, hopefully it comes across that I've put a lot of time into thinking about our aging strategy, I think that is a crucial part of the process. The more effort you put into your planning, the better your chance for a successful outcome. 

If you engage on various socials, threads especially, you might see spammy posts about using AI for financial planning. AI is making progress but not there yet. It would probably take a long time to correct all the spreadsheet errors. A year from now, I'm sure the outputs will be much better. It will happen, but not quite yet. I should note, I did not put any confidential information into AI. 

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. 

A 2% Withdrawal Rate?

About a month ago we looked at an article by William Bernstein and Edward McQuarrie that contrasted people who die with a lot of unspent money and people who Yolo through their retirement without needing or wanting a robust financial cushion in the bank. 

Jason Zweig touched on it in a column this week that included snippets from an interview he did with Bernstein and McQuarrie. There wasn't much that was new in the article but a couple of good tidbits.

“BMWs, fancy clothes and Birkin bags aren’t lifestyle choices, they’re IQ tests.”

From Bernstein, this is obviously about consumerism and spending habits. I don't know which form of overspending, buying too much crap or simply living beyond your means with fixed expenses, is more common but excessive spending is a huge obstacle to retirement success. I realize that is an obvious thing to say but someone you know might benefit from hearing the obvious. 

There was a statistic cited that the stock market over the very long term has a 6.2% real return (real return meaning after inflation). If you don't have a great margin of safety in your retirement numbers I would plug in whether that gets it done for you or not and then I would discount that by 150 or maybe 200 basis points to 4.7-4.2% real return.

That goes back 64 years and is an after inflation number. The 6.2% is stocks only and goes back a couple of hundred years. Targeting Inflation plus 5% is a common hurdle for foundations and endowment so it is a funny coincidence to see 5.08% for this study. 

There was one other idea that I would touch on that got torched in the comments. Having enough is probably more than you think they said. Ok, sounds reasonable. "If your investment portfolio is 50 times your annual spending, you can stop worrying about whether you’ll run out of money." The comments mostly took that literally, I did not. Despite the words investment portfolio being included, I took that as a starting point for planning.

I think of it this as an early step to understand someone's numbers. If someone says they need to take out $60,000 and they have $930,000 in the bank earning nothing, then they 15 and a half years' worth. The default cash option at Fidelity and Schwab each pay effectively zero for taxable account. Someone telling me $60,000/yr for 8 years, well cash might be ok (inflation might be an issue on the back end). Someone who is 54, retired and says it needs to last until they are 90, that might be tough but it is context. It's an early step to figuring out what your asset allocation should be. 

The person only needing the $930,000 to last for eight years might need a little in equities but not much. The person needing it for 35 or 40 years needs a lot more in equities. 

Most people are going to need some sort of normal allocation to equities in order for their retirement math to work. If 60% is the most common equity target, then maybe "normal" starts at around 40-45%. We obviously spend time trying to figure out how to build the portion not in equities. If the non-equity portion can be built into a modest compounding engine with less volatility than bonds with duration then having a little less than 60% in equities becomes mathematically more feasible. 

If even 40-45% in equities is too much, then creating other income streams becomes very important which is why is spend so much on that topic too. 

We all have to solve this for ourselves and once you realize there's an infinite number of ways to solve retirement, it can be motivation to spend more time figuring out your best path. 

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. 

Yield Engine

The catalyst for this post comes from a short writeup by James Picerno about real yields. The idea of manufacturing a high yield while still getting decent growth ahead of inflation is fun thing to toy around with. 

Today's attempt as follows;

There's a little bit of leverage with TECL on the way to a 50% equity allocation and 65% to yield although WTPI does have some equity beta too. By having so much in FLOT, the portfolio doesn't completely whore out for yield. If the entire 65% were in things that yielded low double digits, there would be more erosion in the results.

In looking at this, we don't necessarily care about what the benchmark is doing, we are trying to take yield out and have the remainder grow at a rate that exceeds price inflation.

The Yield Engine portfolio went down less in 2022 but that is mostly attributable to avoiding duration, SPMO and SCHD helped some too. It did not offer any protection or crisis alpha in the Tariff Panic of 2025 or the Iran War decline this year. I'm not sure I would count on the Yield Engine portfolio to reliably go down less in a slow decline but maybe?

The way to protect against the Yield Engine feeling every bit of the next bear market would be to have some number of months of expected expenses set aside in cash in case withdrawing from the portfolio  felt uncomfortable. 

SPMO, SPHQ, SCHD, BKLN and FLOT 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. 

A YieldMax That Doesn't Yield 40%?

You've probably noticed that Microsoft is in a serious drawdown going back quite a few months. This is far from unprecedented in Microsoft's tenure. At some point it will bottom out and I'm sure it will recover and eventually rip higher at some point, obviously I don't know how long any of that will take. 

It seems like a good time to check in on how the YieldMax MSFT ETF is handling the drawdown. The crazy high yielders are fascinating but must be very difficult to own. The total return for MSFO has actually held up better than the common. The marketing pieces talk about covered call funds possibly going down less because of the distributions and that is working out for MSFO this time on a total return basis.

Anyone taking out the distributions is down 40%. The nature of the crazy high yielders is that they should not be expected to keep up with their distributions, they will continue erode at some rate of speed and then reverse split. 

Not all the YieldMax funds are crazy high yielders. The YieldMax U.S. Stocks Target Double Distribution ETF (DDDD) started trading earlier this year. It seeks to pay out twice the yield of SCHD which currently yields 3.3%. SCHD is in my ownership universe. It's too soon to evaluate its ability to generate twice the yield but at a six point something percent yield, it won't be a on a fast path to eroding into a reverse split. 

DDDD reminds me of the Pacer Metaurus US Large Cap Div Multiplier 400 ETF which tracks the S&P 500 and tries to quadruple the yield. So far, it looks like it has done a little better than that. 

There are probably more wrong ways to get more yield (a large allocation to crazy high yielders) than correct ways but it's worth continuing to look. 

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 One's Going To Be Happy

Yahoo syndicated an article from Fortune about the retirement woe facing many baby boomers. The headline talked about boomers hoarding wealth but the article talked about how much trouble many boomers are in. Editors, amirite?

The comments were a hoot, people just going off on the writer because of the boomers hoarding wealth quip but again, that wasn't what the article was about. There probably wasn't anything too new in there but this caught my attention. 

Only about 40% of workers in their early sixties are on track to sustain their standard of living in retirement; the typical near‑retiree faces about a 24% income gap, roughly $9,000 a year.

Thinking about a number, $9000 in this case, and trying figure out how to cover it is a slight tweak to how we and many other blogs cover it. 

If $9000 is some sort of common shortfall, how can it be covered? I think that too many people don't actually break out their expected expenses for when they retire. We've been quipping for years that you don't need to save for retirement after you've retired. At some point a house will be free and clear of the mortgage. The first thing I thought of for trying to find $9000 is to wonder about car payments. A $40,000-$50,000 vehicle is far from a shitbox and also not extreme luxury. The typical payment for a car in that range is about $800/mo. Drive your car longer and there's your $9000.

I don't know how many people that example helps or how often it can be that simple but ultimately, it comes down to spreadsheet work, itemizing expenses. What do fixed monthly expenses add up to now (for context) and what are they likely to be after retirement. If $6000/mo at 55 years old includes a mortgage payment and a car payment and those will be paid off, then maybe $6000 drops to $3000 or $3500 at age 65?

Now, how much are regular expenses that only get paid once or twice a year like maybe car insurance or property tax? Are these likely to change? Our list is about $13,000/yr which includes very expensive homeowners insurance due to where we live, property tax and propane (only need that every 3 years or so). I realize some of these can be paid monthly. 

Unbudgetable one-off expenses is a line item we talk about frequently like new tires, a veterinarian bill or something else in the low four figures. My own belief is to earmark maybe $1000/mo but if you're sort of unlucky with this stuff (we had a very unlucky year a few years ago with a plumbing issue and car issues) then maybe earmark a little more. 

How much would you like to set aside for affordable fun? If expensive trips are unlikely, what is there that you're interested and that is accessible? From Arizona, there is no shortage of hiking, national monuments, national parks, the San Diego Padres all within one day's drive. 

Once all of that is dialed in, what do the known income sources add up to? How does that compare to expenses via the process we just went through above? If the income barely covers the expenses, that's not a bad outcome but there's very little margin for error. If the income is just a little short, then maybe just a little belt tightening can solve it. If the gap is big, like $9000, what can you do if the car payment example or something like it doesn't solve the issue?

Can you work some sort of part time gig or monetize a hobby? Downsizing where you live might be a little more difficult than it use to be but in Arizona, the median price for a three bedroom house in Phoenix is $475,000 (seems low) and in Scottsdale it's $875,000 versus $350,000 in Tucson. In terms of family considerations, it's only a two hour drive. 

This is obviously a problem that we all need to solve for ourselves. The more effort we put into solving it, the better off we'll be. 

And a quick pivot to a plan promoted by Senators Moreno (R-Ohio) and Warren (D-MA) to solve the Social Security problem by eliminating the income cap. At some income level, $184,000 in 2026, people no longer pay employment tax. Eliminating the cap has long been a regular talking point about how to address, either fully or partially, the shortfall that awaits Social Security. This seems like it would be especially painful for people making $200,000-$300,000 and living in very expensive cities. 

The comments on the article are very negative of course. It is worth remembering that whatever they come up with, it can't possibly be "fair" to everyone. A couple of weeks ago I invoked a cliche about a good negotiation being one where no one feels good about it. That might be where we are headed with Social Security. 

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. 

Retirement Planning Isn't Always Tidy

Some very quick hits today.

That free money from SpaceX deep in the money calls that we looked at on Saturday is looking a little less free and the options are looking a little less deep after today's close.

Again, I certainly don't know what SPCX will do but the options market doesn't usually give money away. 

David Blanchett has a paper out titled The Foundations For A Truly Successful Retirement. It covers the usual suspects in terms of social connections, a few others including that having more money makes for a more enjoyable retirement, go figure. There was one interesting point that we've probably talked about but that Blanchett worded differently that I think is useful regarding annuities or some other way to get lifetime income. 

The paper says that both retirement accounts and lifetime income streams are both wealth (read the paper for context) but people are far more emotionally comfortable spending from some sort of lifetime income stream than they are from their retirement account. Yes this makes sense almost to the point of being obvious but it resonates. If some income stream is guaranteed, it's not that you are taking zero risk, it's more like you're not seeing the risk. That's not very tidy intellectually or mathematically but emotionally? Sure why not? I continue to believe there will be ways to annuitize income without annuities as we know them today, we'll see. 

Long time readers might recall how involved I used to be with Seeking Alpha. For a while, I had the most followers of their contributors. I was a very early outside contributor. It's possible that I was literally the first outside contributor. I feel like the site sort of evolved into being more of a 10 Stock Picks For Summer! type of publisher. A few years ago, I submitted something to see what the publishing process was like and the feed back was they wanted stock or fund picks. I broke off with them when they edited out a mention of a book I wrote from one of my posts. 

Every now and then, I circle back to see if I am missing anything in terms of content quality. I used to poke fun at the dividend zealots that dominated the content and while I don't know if anything dominates the content now, I took a look and found an article on a closed end fund that interests me. I'm not linking to the article but it belied a misunderstanding of many aspects of closed end fund investing and the fund itself. One of the two comments was more useful than the actual article. 

Carter Worth, you might recognize his name as a regular on CNBC many years ago (is he still on?), has a new derivative income fund with symbol WRTH. It sells straddles on stocks that have moved 10% in reactions to their earnings. The website shows that other that treasuries, it only has straddles currently on two stocks. It will target an 11-12% distribution which would include about 1/3 of the distribution coming from the T-bills it holds. 

It's not obvious to me if it will be able to always maintain the 10% earnings move strategy. What if there aren't any?

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.