There was an SNL skit many years ago set in some sort of clothing store and the customer picked up an item and asked if will shrink. The store worker said "do you want it to shrink?" I don't remember who was in the skit but the joke lives on the front burner in our house, my wife and I use that line all the time.
It's the same way when evaluating liquid alternative investments. When you read the description of any of them they all seem to tell you what you want to hear, frequently something like having good upside capture while minimizing the downside. That gets us to the catalyst for this post which is a quick video by Eric Crittenden who manages the Standpoint Multi Asset Fund (BLNDX/REMIX) that I own personally and for clients. The TLDW version is that many (most?) alternatives take some sort of risk that is either similar to equity risk or fixed income risk and because of that, they don't work when you need them to.
"Will this fund go up in a down market?"
"Do you want it to go up in a down market?"
"Well, will it keep up in an up market?"
"Do you want it to keep up in an up market?"
That might be a little unfair but it's funny and why I've been writing for so long about understanding what the fund or other product should actually be expected to do. The earliest example of this is probably back to the first version of my blog when I would regularly say in regard to owning gold, if it's the best performing thing you own, then chances are things aren't going so well in rest of the world. You don't want gold to be doing well. Similarly with managed futures, it tends to have a negative correlation to equities. That sets an expectation that it won't do very well when stocks are going up. Anyone holding that strategy should understand that going in, there's a good chance it will go down when stocks go up.
This year, stocks are of course down a lot and just about every managed futures fund is up a lot because that is what the strategy tends to do in a down market.
I've referred to both merger arbitrage which I've been using for years, and convertible arbitrage which I have never used before as proxies for what investors would hope fixed income would do price wise which is to say both tend to be horizontal lines on the chart with a slight tilt one way or another, hopefully an upward tilt. These are non-volatile holdings which means they should not be expected to go up a lot like managed futures when stocks go down a lot. Merger and convertible arbs can lower the portfolio's volatility, that is the expectation, they will not offset stock market declines.
Owning some of each is a form of diversifying your diversifiers, stock market diversifiers that set completely different expectation if you understand the strategies.
A reader asked about TIPS and the iShares Fund in the space with symbol TIP which has benefited from the increase in CPI but the price is still down a lot because it has a fairly long duration versus short dated TIPS funds like iShares STIP and PIMCO STPZ which I own personally and for clients. TIP is down 16% YTD while the shorter funds are down about half as much on a price basis.
Where I talk about avoiding the full brunt of large declines, the shorter dated funds are avoiding the full brunt, that is my goal. I don't figure that I can avoid the entire decline but I like my chances avoiding the full brunt. That is the correct expectation with short maturity fixed income funds. Not down zero, down less with the understanding that nothing will be perfectly infallible.
Correct expectations apply to plain vanilla equities too I think. We're in a bear market. What tends to hold up better in bear markets, what sectors? Most would say that staples, utilities and healthcare tend to go down less due the nature of the elasticity of demand for the products, these things are said to have inelastic demand. If you need medication, a bear market or recession will probably not alter your consumption of the medication. Sure enough, those three sectors are down less this year. Utilities as measured by the XLU ETF are actually up this year. When stocks are broadly going up though, it doesn't make sense to expect utilities and soda stocks to lead the way. They might but that is not the expectation.
All of the above is why I occasionally test drive funds for possible use in client accounts. Where almost all of them say they give upside and avoid downside, to Eric's point from the video, a lot of them actually don't. If I think a particular fund might actually do what it says or if I think I have a good enough understanding to isolate out what the real expectation should be and I find that compelling, then I might test drive it.
I mentioned the presentation I sat in on earlier this week. I got some followup literature that included info about the Franklin K2 Alternative Strategies Fund (FABZX). It is a multi-strategy fund using what I count as 17 managers across four different complex strategies. This would be an example of complex complexity and I am not going to pursue it at all. It looks similar on the chart to merger arbitrage although this year, merger arb has outperformed it dramatically with FABZX down about 750 basis points and MERFX up 11 basis points (I wasn't kidding about horizontal line with a slight tilt up). I think the real expectation multi-strategy sets is that a lot of things have to go right for it to work and tracking those things is far more difficult than tracking a single strategy fund like merger arb.
Let's close this out with risk parity and not meeting expectations...I don't think it does anyway. A couple of guys in Complex Portfolio DIY Twitter were having a convo about why one of the risk parity funds wasn't doing well this year. I suggested that it doesn't work in retail-accessible funds maybe due to the constraints of those wrappers, maybe it has something to do with how mutual funds can lever up. Mind you I am just giving it the benefit of the doubt that it works in different pools of capital but not even AQR could make it work in a mutual fund. Maybe we could figure out why, maybe not but that doesn't matter, it just does not work in a fund. Is the expectation it is trying to set, an all-weather? Maybe, but it fails that in fund form. Risk Parity is intriguing and so you want it to work, I do, which I realize sounds odd, but it doesn't
No comments:
Post a Comment