Getting Nothing But Static In My Portfolio

Adam Butler Tweeted the following

 

The green line is essentially the 75/50 idea we first looked at years ago, before the Financial Crisis believe it or not. The idea is attributed to John Serrepere who I knew when I worked on the Schwab Institutional Equity desk in the mid-90's and John was a customer of the desk. He popped up ten or so years later writing occasionally at the old Index Universe website which later became ETF.com. 75/50 targets 75% of the upside and 50% of the downside. If you do the math, that yields a better long term result in nominal terms and also in risk adjusted terms. 

Getting that exact result is not going to be easy for too many people but the idea of structuring a portfolio to be less volatile while avoiding interest rate risk is something that someone who is so inclined can do. We've been writing about this all summer. The reason 75/50 resonates with me is because it tries to quantify what I have always described as avoiding the full brunt of large declines. 

The area inside the red box on the chart would be difficult to ride out. The green line is an AQR fund with a short track record. The fund is the AQR Diversifying Strategies Fund (QDSIX) and this is what is under the hood.

 

If you've been reading along through this bear market, you might recall that I want no part of this sort of complexity in one fund. Most of those strategies are themselves complicated and how they might interact is another layer of complexity. There are things to learn here though or if you have been reading along here, things to reiterate. Using managed futures can help. Using certain types of arbitrage can help but do so in a way that is different than managed futures. Certain types of long/short, probably captured on the pie chart under equity market neutral, can help. Continue to learn about new (to you) strategies and various funds that might come along to offer protection is a way that is different than other protective funds can help.

Where QDSIX was stagnant for kind of a long time addresses a point that I try to incorporate into client portfolios which is not to thing in static terms. Market conditions change, market cycles come and go and I think there is some navigation that can be done. 

For years I've initiated defensive action in client portfolios when the S&P 500 breached its 200 day moving average (DMA). On this cycle I started when the S&P 500 got 20% above its 200 DMA which was about a year ago. Just slight changes to reduce the portfolio's beta, the extent to which it looked like the index, a little bit. That far above or that far below typically is not sustainable. I got a little more defensive on the way down from there. That was done not because "I knew" a top was in, I didn't, that move was several months early but 20% above the 200 DMA means there is more risk of a decline. You can know when risk is elevated but you can know when or if there will be a consequence. 

In June, the index got close to 20% below its 200 DMA and I added in a little equity exposure for what turned out to be a short term trade for how quickly the index rose. I sold that exposure fairly quickly and too early relative to the run. I did not do that trade because "I knew" a bottom was in but I knew that 20% below the 200 DMA there's a lot less risk. I told clients that any buying we might do when the stock market is down a lot could easily be "wrong" a couple of months from now but is right for the longer term.

I think static allocations are not ideal. Depending on your engagement with markets, avoid static allocations might be worth pursuing.