Thursday, June 30, 2022

Not Just Wrong About Investing, Wrong About Life

Yesterday we wrote about whether it makes sense to go heavier into liquid alts with an article from Morningstar as the catalyst. As a follow-on, the Wall Street Journal also looked at liquid alts, noting how well they have done and citing the Morningstar piece. 

I want to start with the comments on the article. The commenters seemed to all be unaware of alts, were almost all skeptical or worse ranging from doubtful to believing alts are crypto-like scams. There was one guy who though, I think he's an advisor, who mentioned Pimco Managed Futures repeatedly in an effort to defend the space. 

Here's one comment that I think captures the sentiment;

These funds are not appropriate for virtually any retail investors. The strategies and their place in a complete portfolio are too complicated for any but sophisticated professionals to understand. Further, while some of these funds are founded in legitimate theory, many others are not. In all cases, one thing is certain - the strategies will work until they don't. They will all fail catastrophically when the market decides to humiliate them.

So there's a lot to dissect here. First, no one can determine what anyone else should do, that's silly on its face. Plenty of people who are not professional investors can understand at least some funds in the space. In most instances, the ability to understand comes down to someone's willingness to spend the time and having the desire to do so. No one will understand all the funds out there, I certainly don't, but that doesn't mean you shouldn't make the effort. Declaring that all of them will fail catastrophically is pretty hyperbolic. 

If you don't want to use alts, don't use alts. The comments might be a good indicator that a lot of people don't. It is perfectly valid to stick with plain vanilla stock and bond exposure. That, combined with an adequate savings rate, suitable asset allocation and the wherewithal to avoid panic will probably get the job done. 

If you've been reading my content on this subject for even just a little while, you know why I believe in them and that either resonates or it doesn't. But the nature of markets, investing and all the rest is that the (investing) world evolves and if you're going to manage your own portfolio, I believe some time should be spent trying to learn more in order to at least partially keep up with how things evolve. If you're an advisor of some sort, then you owe it to your clients to keep learning. Alts are one example, crypto is another. Crypto has been around long enough, that any advisor should be able to explain it to a client, even if the answer is why they shouldn't buy any. 

The willingness to learn about alts and crypto also serves as a metaphor for staying curious more broadly. Staying curious is a crucial element of successful aging; keeping the desire to learn new things. "Alts are bad news for you and everyone else and no one should even try to learn," as a metaphor, is simply the wrong outlook for life. Specifically alts, who cares, but the person engaged enough in investing to read the Wall Street Journal and go so far as to comment is probably someone who should be learning more, not closing doors. 

To the article itself. It specifically mentioned client and personal holding AGFiQ US Market Neutral Anti Beta ETF (BTAL) which according to Yahoo Finance is up 22% YTD versus a decline of just over 20% for the S&P 500 and 17% for the Vanguard Balanced Index Fund (VBAIX) which is a proxy for a 60/40 equities/fixed income portfolio. 

The article quoted Nicholas Rabener saying you should not buy funds that charge more than 1.5%, "it's difficult to justify that cost." Bobby Blue (that's his name) who wrote the Morningstar article said some funds are worth the price tag. As we looked at yesterday, a 20% allocation to BTAL would have spared investors about 700 basis points of decline this year despite charging 2.53%. The management fee is actually less than 50 basis points, the rest goes to the cost of implementing the strategy, it costs money to short stocks. Is the 22% gain for BTAL worth it? Is the 700 basis points spared at this point worth it? That's up to anyone pondering the fund for their portfolio. That's not for me to say or for Rabener to say or anyone else. There's no wrong answer.

There was criticism in the comments about this article being late. Yes it is late in one aspect, but not late in another. We're a long way in to this market event in terms of price even if not time. I've been writing about alts forever but am hardly widely read anymore but the Journal article, written like hey, we found  these brand new things no one knows about might be too late to have a great impact for the current event like this same article might have had a couple of years ago.

Where it's not too late maybe is in a longer context. Bonds were essentially a one way trade for 40 years. That appears to be over. What if bonds now will be more of a two-way, cyclical performer? All of the portfolio theories and research and the rest quickly lose relevance if long bonds regularly go up and down 15% in a year or two, they'd be trading more like stocks. The iShares 20 Year Treasury ETF (TLT) is down 22% YTD, total bond market index funds are down 11% YTD. Portfolio theories and research are built on bonds offering ballast against stock market volatility. If that is no longer reliable then it's back to the drawing board to try to find asset classes, products, alts that as I've been describing, do what investors would hope that bonds or bond funds would do but no longer will.

If that scenario holds any water then alts seem like they become more important so don't stick your head in the sand.

Wednesday, June 29, 2022

Bruce Dickinson Says "I Gotta Have More Trend!"

Morningstar took a deep dive on alternatives, really deep. 

There was one line that jumped off the page at me; as stocks and bonds soared throughout the 2010s, the average systematic trend fund lost 0.6%. A 20% allocation to the average systematic trend fund in a 60/40 portfolio would have resulted in an annual drag of about 1.45 percentage points.

A 20% allocation to systematic trend, aka trend following aka managed futures, was only a 1.45% drag? That seems like a big weighting and a small drag. Turns out the math checks out using Vanguard Balanced Index Fund (VBAIX) which is a proxy for a 60/40 equities/fixed income portfolio and the Guggenheim Managed Futures Strategy Fund (RYMFX). This is the fund I mention all the time that I owned for clients through the financial crisis that used to have the Rydex name. 

Per Yahoo Finance, VBAIX has a ten year annualized return of 9.54% and RYMFX had a ten year annualized return of 1.99%. I get an 80/20 blend VBAIX/RYMFX with a ten year annualized return of 8.03%. YTD VBAIX is down 18% while RYMFX is up 16%. Putting 20% into RYMFX at the start of the year would have the VBAIX/RYMFX blend down 11.2% versus 18% for 100% VBAIX. Over the ten years you still would have been better off 100% VBAIX but the large allocation to RYMFX is helping a lot this year. 

A 20% allocation to RYMFX would have helped in the first three months of 2020 albeit with less of an impact. VBAIX was down 11.45% (bonds didn't break during that one) while RYMFX was up 1.21%. An 80/20 VBAIX/RYMFX blend would have been down 9%. It did even less during the Christmas Crash of 2018 when VBAIX dropped 12.6% but RYMFX dropped 5.5%. In that scenario the VBAIX/RYMFX 80/20 dropped 11.8%

I have conflicting thoughts. Giving up 1.5% per year for a smoother ride wouldn't bother me personally but fair game for anyone for whom that would be troublesome. Using client holding BTAL the same way, a 20% allocation blended with 80% in VBAIX would be down 11% this year (about the same as RYMFX), would have been down 5.8% in the first three months of 2020 and down 7.9% in that same 2018 event. BTAL would have offered much more of a buffer during those drawdowns. So 20% in BTAL then, not RYMFX?

BTAL's 10 year annualized return is a loss of 0.99% so the drag for 20% in BTAL over that time would be more like 200 basis points per year versus 150. Again, no wrong answer if that is unacceptable. 

Another wrinkle to 20% into one alt strategy is that no single strategy should be expected to work every single time. In 2018, RYMFX didn't "work" but that clearly did not invalidate the fund or the strategy. I've always talked about putting small amounts into several alts for that very reason. I kind of cherry picked the three declines to look at, choosing the last three. IMO, BTAL is a great fund but I do not expect it to work every time, that is unrealistic. 

I think it was Jason Buck from Mutiny Funds who said "diversify your diversifiers." That's what I've been doing all these years and I suppose all of these posts about this lately is my exploration to see if I can find better diversifiers than the ones I currently use or add in one or maybe two to improve the overall effect a little bit. Plus, this is a lot of fun to learn about. 

The Bruce Dickinson reference in the title is of course a reference to the Cowbell Sketch on Saturday Night Live 22 years ago.

Monday, June 27, 2022

Old Concept With New-ish Name

Quite a few years years ago, like maybe 15, I wrote several posts about an idea for portfolio construction from Nassim Taleb where he said he put 90% of his money in T-bills from around the world and then put the remaining 10% in very aggressive holdings with great potential for asymmetric returns. If he had 10 names in the very aggressive tranche and one them was a 10-bagger while the others had some normal return dispersion then that one name that went up 10 fold could add 900 basis points of return which could "stack" on top of the T-bill yields for a market equaling return for the entire portfolio while only risking a small amount of the portfolio.

Another example of this from my past, working at Fisher Investments 20 years ago, a couple of my smarter co-workers were intrigued by the fact that allocating 2% to a position shorting Nikkei futures, putting the rest in cash provided a return that was inline with the S&P 500. I don't know whether they were right about that but the idea of equaling the return of the S&P 500 with just 2% of investment capital is fascinating. 

It turns out there's a name for this, capital efficiency. The simplest example of an investable product I know for capital efficiency is the WisdomTree US Efficient Core Fund (NTSX). If you engage in ETF Twitter at all, you might know this one as the 90/60 ETF. Using futures, it allocates 90% to equities and 60% to fixed income. That is the same ratio as 60/40 equities/fixed income.

If an investor had $100,000 to invest, they could put $67,000 into NTSX and capture $100,000 worth of the Vanguard Balanced Index Fund (VBINX) which is a benchmark fund for a 60/40 allocation. Does it do what it's supposed to? According to this white paper from ReSolve and Newfound, it does.


This year, VBINX is down 18% while NTSX is down almost 24%, the math appears to check out. If you only put 67% into NTSX, with the rest in cash you'd be down 18% but you'd have earned a few basis points of interest on the cash not invested. 

What you do with that cash is where the conversation gets more interesting and more complex. A potential benefit of the capital efficiency offered by NTSX is return stacking. The link above goes into greater detail, talking about the construction of a very sophisticated return stacking index. Here is a simpler example from Seeking Alpha. In the Seeking Alpha post, they talk about capturing all of a portfolio's notional equity exposure from a long position in futures contracts. The SA article says a position in futures might only require 5% margin. So to get $60,000 of equity exposure (sticking with 60/40 for $100,000), an investor would put up $3000 to get their full equity allocation. Then put $40,000 into a normal bond portfolio and have $57,000 to put somewhere else. The conservative thing would be to buy $57,000 in T-bills that hopefully have a decent yield. This sort of return stacking is more like leveraging down as opposed to leveraging up. You should not be taking any more risk with that and you'd be getting a few more basis points in yield stacked on top.

A way to do something similar with ETFs would be to put 20% into a 3X leverage S&P 500 ETF, 40% into a regular bond portfolio and then do something else with the other $40,000 like T-bills. In theory this would not take any more risk than 60/40 and would earn a few more basis points of yield. This one is a little trickier if the daily reset of the 3x funds works against you. That is unknowable of course but as an example, it explains it pretty easily. 

Back to the white paper linked above from ReSolve and Newfound who built a return stack portfolio that is far more sophisticated than my examples. 


The columns starting at 'equity' and moving to the right give the attribution of how much exposure each fund gives to the entire portfolio. NFDIX gives the portfolio/index 11.2% of equity exposure out of a total of 62%. The total notional exposure is 161% so it is leveraged but leveraged such that it is blending different correlations in an attempt to deliver a similar, but better return than plain vanilla 60/40 and do so with less risk taken. 

Getting some disclosures out of the way; BLNDX is a client and personal holding, I am test driving RDMIX for possible use in client accounts, in the past I test drove MBXIX and SPYC and decided not to use them. 

I am more interested in the capital efficiency aspect of this versus the concept of leveraging up. Dialing back from a 3X ETF to maybe a 2X, 35% to Proshares Ultra S&P 500 ETF (SSO) works out to a 70% allocation to equities (a similar daily reset risk exists). I am seeing a different way to use risk parity which is listed at the TYA ETF in the table. The TYA fact sheet implies it provides 300% exposure to longer dated treasuries. If an investor wanted long bond exposure, I do not, then 7.5% into TYA provides a 30% bond exposure thanks to it's leverage. So between SSO and TYA we now have a 100% allocation and still have 57.5% of our investment capital in cash. That's capital efficiency Holmes. 

The remaining 57.5% into T-bills maybe. Maybe a percent or 2, no more, goes into Bitcoin or something else with similar asymmetric potential. If you were intrigued at BTC $50,000 or $60,000, you should be more so down here at $20,000, of course Bitcoin-zero is still a possibility. 

The mix so far would be pretty volatile, you'd feel a full 100% with this allocation. If you work in some managed futures and tail risk you would mute some of the volatility and build in something of an all-weather outcome, or at least potential outcome. The allocations to managed futures and tail risk would be small in the context I am talking, like a combined 7-8%, mostly in managed futures. Then instead of all T-bills, I might add in a little bit of short term TIPS exposure and a small bit to gold. 

As it stands now, I am not going to do this. It is fascinating to study and take influence from and I am thinking about risk parity a little differently too. There are elements of this being too academic/theoretical and it relies a lot IMO on how things should work. I don't want to be overly reliant on a complex portfolio with many moving parts that needs things to do what they are supposed to do in order to not blow up. 

One way to perhaps ease into return stacking could involving going back to NTSX. We know 67% into NTSX equals 100% of 60/40. What about leveraging that up slightly to get 110% exposure to 60/40 or 66/44? That would mean putting 73.7% into NTSX. We know from above that 100% into NTSX this year is down just under 24% so you'd be down less than that, down close to 20% this year. That by itself is not dangerous leverage. Putting the remaining 26% in a 3X fund would be dangerous leverage, putting it all into a mix of lottery ticket biotechs and uranium miners would be dangerous leverage but some mix in there of managed futures, tail risk, maybe merger arbitrage which we haven't talked about yet in this post, TIPS, gold, cash/T-bills and a percent or two in asymmetry and I think you have an all-weather-ish portfolio with the potential to deliver a market like return with less risk.

Although it closed a couple of years ago, there was a 1.25X levered ETF, the PortfolioPlus S&P 500 ETF (PPLS). For me, this is all a theoretical exercise but there's a wide contingent of very smart portfolio managers who seem to be all in on this. If I am too skeptical about this and people like the guys at ReSolve and Newfound are right, then funds like PPLS coming back is likely to happen. 1.25X and 1.5X leverage would be useful pieces of the capital efficiency/return stacking puzzle.

Avoiding Overly Sophisticated Portfolios

Let's continue the conversation about all-weather generically and then the Cockroach Portfolio. First a comparison of the Permanent Port...