Unreliable Volatility

A round up of a bunch of things. 

A few months ago, I started referring to bonds as being a source of unreliable volatility. Bespoke Investment Group noted that the iShares 20+ Year Treasury ETF (TLT) is up 16.8% over the last month while the S&P 500 is up a little over 4% in the same period. The yield curve is obviously trying to price something in, maybe a (declared) recession, maybe a pivot by the FOMC, maybe something else, whatever, that is a big lift regardless of the reason. 

I have no doubt there will be more trades to be had, regardless of direction with funds like TLT, the fund's volatility has been escalated all year with the 16% jump simply being the latest. Trading bond funds for capital gains is not my trade. For me that would amount to guessing what comes next. If the environment of big swings both ways in the price continues as it has, seems plausible right, then that means they remain volatile, for my money they remain a source of unreliable volatility. If you accept that thesis then longer bonds become less effective tools for diversification. Trade away if that's what you do but the rest of us should be prepared for the likelihood that long bonds' diversification benefit remains diminished for the foreseeable future.  

A concept I have been espousing forever is that you don't know what the future you will want to do. That goes back at least to my early days side-gigging at AdvisorShares, maybe earlier. Regardless of when we started exploring it in various places that I've written, it's a big one about optionality and it's one of the ideas that I've pretty much built my life around. I make no claim of originality but here's a post from Humble Dollar saying the same thing, kind of verbatim. Whether you call it playing the long game, low time preference, delayed gratification or doing favors for your future self, it is a crucial attribute to incorporate into your life. 

You might love what you do but what if out of the blue you want to do something different ten years from now? The context we've talked about the most is having adequate savings in case you want to do something that pays much less money but would make you much happier. Related is keeping yourself fit in case the thing that pays much less money but would make you much happier requires some sort of stamina or physical engagement. 

Institutional Investor had an article about managed futures concluding that an investor needs at least 10% exposure to managed futures in order to get meaningful portfolio benefit from them. Maybe, maybe not. Managed futures is not the only alternative strategy that tends to have a negative correlation to equities. I don't know what sort of dramatic thing could go wrong with managed futures but it generally endured years of underperformance as equities rallied in the previous decade. A 10% allocation is a lot in my opinion. I think it is a worthwhile endeavor to learn about those other negatively correlated alternatives if you haven't done so already so that 10% of things with negative correlations relies on several different strategies working independently via different funds. Diversify your diversifiers.

Finominal asks whether alternative ETFs are good diversifiers looking at nine funds in the space with at least five years of track record. It doesn't seem like they are favorably disposed as just two of the nine actually had a negative correlation to equities and just three had a negative correlation to bonds.  

I think this comes down to having the correct expectations for a given alt and an adequate understanding of the strategy. We've explored this repeatedly. Some strategies have the tendency to go the opposite way as stocks. There are times when that attribute is very desirable and other times where it can be frustrating. Anyone spending the time to understand these points will know what they are getting when they buy. If markets rip higher, then yeah your managed futures fund is very unlikely to go along for the ride. If you buy convertible arbitrage as a hedge, the correct expectation is not that it will go up a ton when stocks drop but that it will be a horizontal line the vast majority of the time. 

First, investors need to figure out if they even want this type of exposure then spend time really understanding what they will/won't do and then spend more time assessing or game planning how to build them into a portfolio to have a reasonable shot at whatever realistic outcome they are going for.

No position in TLT and no intention to buy that fund personally or for clients.