Regret Waiting To Happen

There has been discussion in the last couple of days in articles and Tweets trying to look at some of the drawbacks with bond funds beyond the obvious and what might be described as an exploration about what to use instead of bonds, like the types of alternatives we've been looking at for a long time here. 

We've probably talked 100 times about the extent to which bond funds can drop in price. Cullen Roche compares that to holding individual bonds which despite the possible decline in price, holders will get their 100 cents on the dollar back at maturity so clients tend to worry less than with bond funds which have no par value to return to. Concern about bond fund fluctuations could lead to bad behaviors is Cullen's main point.  

Rodrigo Gordillo, one of the managers of the Rational/ReSolve Adaptive Asset Allocation Fund (RDMIX/RDMAX) Tweeted that he was at a conference where participants explored the current macro threats but didn't seem to have ideas about how build portfolios that might better weather the current market event. Regardless of what you think about RDMIX, the fund is certainly on the cutting edge of portfolio construction and probably well situated to make that critique of a panel of macro strategists. 

AQR of course manages a suite of alternative strategy mutual funds. Its Honcho, Cliff Asness Tweeted out a good article from Bloomberg about several types of alts that should offer protection but haven't really done so. Asness took the opportunity to mention how well trend following (managed futures is a type of trend following strategy). Of course AQR has a managed futures fund which after a long run during the bull market for equities were it lagged by a lot, is absolutely killing it this year.  

The Bloomberg article hit on funds that buy put options one way or another having not really given too much protection. The article cited the nature of this bear market having been slow as opposed to a fast crash as a reason. Also certain VIX products have underwhelmed too. I would add some VIX funds have done ok though. 

Buying puts is absolutely a valid strategy. It turns out some the funds that buy puts haven't worked out on this go around but long puts is valid, just not infallible. Managed futures is absolutely a valid strategy. It turns out some of the funds that run managed futures have worked out very well this go around, it is a valid strategy but it too is not infallible. There are plenty of alternative funds that are valid, some have worked out very well this time, some have not. The next market event the opposite could happen. Maybe funds that buy puts will be huge winners and managed futures will disappoint. I have no idea which is why you diversify your diversifiers.

Eric Balchunas Tweeted out about how much new AUM has gone into managed futures this year. The strategy is getting a lot of attention because it is doing well. There are some who will tell you to put 15, 20, even 25% into managed futures. This behavior repeats, we've talked about it before. Something does fantastically well and then experts tell us to go heavy. I've made this point before, this event will end and when stocks start to do well again, it is likely that managed futures will get left behind.

Allocating a small portion of a portfolio to holdings that usually go the opposite direction of the stock market makes for good diversification. Putting 1/4 of a portfolio into one strategy that usually goes the opposite direction of the stock market is regret waiting to happen. One sequence of going down in a bull market for stocks followed by not "working" in the subsequent bear market would be a deep hole to dig out from.