Capital Efficiency From A Fire Cracker?

Circling back a couple of posts to the podcast with Meb Faber, Corey Hoffstein and Rod Gordillo, there was a quick mention of a fund that owns two year treasuries levered up 3x. They didn't say the name but it is the Simplify Intermediate Term Treasury Futures Strategy ETF (TYA). This is a fund I have mentioned a few times. I have no interest or intention of using it but I believe it is useful in gaining understanding of how capital efficiency, aka return stacking can work. 

 

TLT is is 20+ years and IEF is 7-10 years. As you can see, TYA got pasted last year. Should an investor who wants their fixed income exposure from treasury ETF instead of a broader aggregate bond index dismiss TYA or the underlying concept altogether? 

Looking at the nominal result, down 37%, is not the right way to look at the fund. It leverages up 3x which takes the duration up to 18 per the Simplify website. At one point, I was told via a Twitter convo with someone from Simplify that leveraging up the 2 year treasury futures makes TYA comparable to a 10 year treasury. So I compared it to IEF on Portfolio Visualizer to dig in a little more.

 

Portfolio 1=100% TYA

Portfolio 2=33% TYA/67% CASHX

Portfolio 3=100% IEF

Using TYA in the correct portion looks a lot like 100% IEF with slightly better numbers.That time period is as far as it goes back for TYA so while the sample size is small, so far a 1/3 allocation to TYA seems to replicate 100% into IEF with money left over to for return stacking (also known as portable alpha). Continuing the example with TYA, a 13.33% allocation might replicate 40% into IEF, leaving 26.67% for return stacking or maybe just leveraging down and parking that 26.67% in cash yielding 4-5%.

Where the guys on the podcast were willing to add 60% to managed futures on top of 60/40, let's see what that 26% in managed futures would look like. Is it worth doing versus plain vanilla 60/40 in the Vanguard Balanced Index Fund (VBAIX).

 

And the results.

 

The time period is short, a ten year sample would certainly be more informative. Arguably, the strategy is pretty straight forward versus some sort of more exotic strategy. The portfolio with the return stack allocation performed noticeably better than the plain vanilla. 

Return stacking is valid but just because it is intended to be less risky than plain vanilla doesn't mean it always will be. Such a big bet on one alternative, managed futures in this case, could have gone the other way in 2022. Yes, the strategy usually does well when stocks do poorly but it is not a direct cause and effect like an inverse fund.  

The entire return stacking concept is valid but where it can involve leverage, it becomes easy for investors to end up using too much leverage but not understanding they had too much until after something breaks. Where I always talk about understanding the positives and negatives of any product you might use or overarching strategy embedded in your portfolio, using leverage makes that even more important to do.