Deconstructing Return Stacked™ 60/40: Absolute Return Index

We've taken a couple of different looks at the Return Stacked 60/40: Absolute Return Index but I thought it would be fun to put it through portfoliovisualizer and maybe compare it to a couple of other things. As a reminder, this is the allocation. 

 

One of the building blocks of understanding of return stacking is that it uses leverage in a way that should be less aggressive than buying $20,000 worth of one stock using only $10,000. Because several of the funds are new this year, I made a few tweaks to the holdings to allow my backtest to go back to the start of 2020. As I've mentioned before, a lot has happened in the last 32 months and I think that is a decent time frame to study, even if not ideal. Here's the portfolio as I tweaked it.

 

Portfolio 2 is 100% SPDR S&P 500 (SPY) and Portfolio 3 is 100% Vanguard Balanced Index Fund (VBAIX) a proxy for a 60/40 portfolio. SPY isn't the right benchmark for Return Stacked 60/40: Absolute Return Index but I always want to see how far are we diversifying away from 100% equities. Here are the results.

 

The CAGR is noticeably better than VBAIX while the standard deviation is slightly better, almost a push. The worst year and max drawdown numbers are much better for Portfolio 1. In 2020 it lagged behind VBAIX, in 2021 it outperformed VBAIX by 253 basis points and this year it is down much less. The outperformance this year is especially noteworthy because it has almost the same bond exposure as as VBAIX. To the extent the return stack, strategy stack might be a little more precise of a term, is "working," the portfolio benefited this year by having exposures that should go up or at least go down a lot less during normal bear markets like we're having now. 

Other than tail risk protection, aka crash protection, I wouldn't necessarily count on sophisticated portfolios to out perform crashes like the Pandemic Crash of 2020. It did outperform VBAIX by about 200 basis points in Q1 2020, so that's terrific, I just would not count on it in the next crash. Again, I am differentiating between a crash and a normal bear market. 

In that last paragraph I referred to the Return Stacked 60/40: Absolute Return Index as sophisticated. It is also complex. Is it too complex? NFDIX, RDMIX, MBXIX and MAFIX all have a lot of moving parts, BLNDX only slightly less. To my way of thinking, that much complexity relies on a lot of things working the way they're "supposed to." That's not always a good bet. The more moving parts, the more chance of something you cannot predict happening to cause serious problems. 

I don't know what could cause Return Stacked 60/40: Absolute Return Index to have some sort of catastrophic result as the result of some sort of black swan or maybe like a gray swan where both fixed income and managed futures both implode at the same time. Those two add up to almost 70% of the 160% notional exposure. What would cause both fixed income and managed futures to blow up at the same time? If we spent some time on that, we might come up with a couple of plausible scenarios but I'd rather just avoid that altogether.

That doesn't mean there's nothing to learn, no influence or tweak to consider adding to my own process. Learning about the Return Stacked 60/40: Absolute Return Index was a catalyst for me to explore volatility as an asset class, or exposure, and selectively adding the Princeton Premium Income Fund (PPFAX) to certain client accounts and one of mine and to consider ProShares VIX Medium Term ETF (VIXM) for future defensive positioning. 

The ideas of capital efficiency embedded in the strategy of course appeal to me, I've been writing about that for years, long before I ever heard the term. The logical question is can we get a similar result using fewer funds in a portfolio that relies on fewer things going right. Obviously, I think we can.

 

And the results. Note Portfolio 3 is still 100% VBAIX.

 

So Portfolio 2's CAGR is higher, the standard deviation is somewhat lower, even if not dramatically and worst year is mid single digits even if not as good as Portfolio 1 but Portfolio 2 does better for max drawdown. 

Going forward, there's no way to know which would be better of course. I think we can say that 2 is much simpler than 1, fewer funds and the funds themselves are less complicated. I think it is very important that any portfolio that anyone takes on for themselves should be relatively simple, they should think it is simple. The guys who created Portfolio 1 might very well think it's simple and that would be valid. It's not simple for me but again, I've learned from it. Hopefully you have too. 

Other disclosures: RDMIX personal holding, BLNDX client and personal holding, TAIL client and personal holding and BTAL client and personal holding.