Levering Down

You might be familiar with the portfolio strategy known as core and explore. Core and explore can be thought of as having most of your portfolio in very basic, vanilla broad based funds like an equity index fund and an aggregate bond fund and then take a few percentage points of your investable assets to speculate with. Sometimes you might hear something similar referred to as a barbell approach. Barbells are different but similar in some ways, repeated for emphasis. 

A couple of years ago WisdomTree launched the WisdomTree US Efficient Core Fund (NTSX) although it had a different name when it launched. The strategy is to allocate 90% to equities and 60% to bonds, so it is leveraged to 150% net exposure. The fund was the byproduct of a collaborative effort on Twitter. The fund has traded as advertised, that's good, and has also been successful in asset gathering at about $800 million. 

Over the years we've looked at various forms of portfolio efficiency, it's an interesting topic that is a subset of risk adjusted returns. If a portfolio allocates 2/3rds of its assets to NTSX and the other 1/3 to cash, then the result should be equal to 100% invested into a 60/40 portfolio plus the interest earned on the remaining 33% that's in cash. In comparing NTSX to the Vanguard Balanced Index Fund (VBIAX), this fund targets a 60/40 equities/fixed income portfolio, the math mostly checks out. If that's not close enough for you then obviously you wouldn't consider NTSX.

A similar idea could be to put 33% of a portfolio into a 3X levered fund like Direxion Daily S&P 500 Bull (SPXL) and then leave the remaining 66% in cash. The didn't work very precisely over the last two years, probably because of the daily compounding effect during the pandemic crash.

Don't put 1/3 of your money in SPXL, this is a theoretical discussion. Leverage is often viewed as risky when used to lever up. Putting 100% into SPXL would be disastrous during market declines but putting 66% into NTSX or 33% into SPXL (again, don't do this) could be thought of as levering down, not up. If you can get full equity market performance with only a portion of money and able to leave the rest in cash then you will have a better risk adjusted return and that cash is optionality you wouldn't have otherwise had. In case it wasn't clear, don't put 1/3 of your money into SPXL.

When we first had these discussions before Bitcoin was a thing I used the example of putting 1% into something that goes up 10x while leaving the other 99% in cash. You get a decent, not heroic, equity portfolio number while only having exposed 1% to risk/volatility. Every now and then Bitcoin goes on a 10x run. I don't know if that will happen again but it might. 

Again, this is all illustrative of the concept of portfolio efficiency and levering down (new term with this blog post!).

There are probably quite a few applications for levering down. I think of it as a way to be conservative. I touched on my asset allocation the other day and as I think it through, levering down might describe some of my mix. I've been transparent that Plan A is that I never stop managing money, that we take Social Security when I am 70 and continue to rent our our Airbnb. If all that goes to form then we wouldn't take from our portfolio for regular expenses, it would be for large one-offs like if we ever need a car, traveling once the pandemic is behind us and emergencies. 

In the last 10 year, the S&P 500 is up almost four-fold, 274% per Yahoo Finance. Many think that the next ten years will be far below that. What does that mean? A double? 50%? Realistically, I don't know that we even need half of whatever the return might be. What if, like the ten years ending 12/31/2009 its down 26%? That would be a bad sequence of returns. 

We've talked about managing sequence of return risk, there are many ways to do it and levering down might be what I gravitate to; a little asymmetry (crypto), more in vanilla equity, about the same in low vol strategies, a little in tail hedge with cash being by far the largest allocation. My little less than 1% in crypto had grown larger but is not a lifechanging piece of money (yet?). From here, a 10x in crypto would allow us to derisk even more.  

Assess your situation either yourself or with some help, then figure out how to move forward as best you can and be willing to change if you need to.