A little over a year ago I tweaked the name of this site to reference "portfolio lab" as market conditions have in my opinion evolved such that investors can't necessarily completely rely on how portfolios had been constructed in the past. Investment products that help with this issue are proliferating which gives a lot of things to study and learn about and possibly allow us to modify our approach. That last sentence describes what I've done which is studied a lot and implemented a little.
Portfolio theory is also interesting and fun for me so there you go.
That preamble gets us to a short paper from Simplify ETFs that makes a statistical argument for using alternatives. They suggest a benchmark of 50% equities, 30% bonds and 20% alternatives so they are taking 10% each from bonds and equities to build the alts sleeve. By their numbers the statistics make this suggestion valid even if it seems a little random.
The return stack guys implement the idea of using alts differently with capital efficient (leveraged) funds which they say will reduce tracking error. Think about the 90/60 ETF, the WisdomTree US Efficient Core ETF. It is leveraged such that a 67% allocation to that fund equals a 100% in a 60/40 fund, leaving 33% to add alpha or manage volatility or whatever else. The argument that return stacking reduces tracking error is lost on me. So you put 67% into NTSX and then whatever you do with the 33% will either work (you enhance the 60/40 return) or it won't work but you still end up looking different than plain vanilla 60/40.
Taking a step back from this was a post at ETF.com from Allan Roth who made the case for essentially a 50/50 split between equities via a broad based index fund and long dated tips. By Allan's reckoning the portfolio will give you 6% plus inflation. You can decide for yourself on preciseness of his numbers but the idea is a simple combo of equity upcapture and inflation protection. Note that he was saying to buy an individual TIPS issue not a fund. TIPS are kind of a tough hold at times. In 2022 TIPS funds generally did poorly because they are interest rate sensitive as are individual issues. They didn't really react to last year's spike in inflation but as Investopedia points out, that is probably the wrong expectation versus a better expectation where the par value just continues to ratchet up every year until maturity.
Allan looked at a 25 year TIPS. If you were to implement his portfolio exactly as he spelled out, I don't doubt it would work but it would be a wild ride. Long dated TIPS are long dated debt. Maybe the inflation bump would help mute the volatility a little but just a little if at all. iShares recently launched a suite of target maturity TIPS ETFs. The furthest out is the iShares iBonds Oct 2033 Term TIPS ETF (IBIJ). Only ten years not the 25 years Alan studied. These are so new that I don't know whether they could substitute for an individual TIPS of the same maturity but it certainly would be easier to manage.
When I saw the Tweet (Xeet?) for Alan's article I commented that it would be an interesting idea for a return stacked combo along the lines of NTSX or the new RSBT (bonds/managed futures) and RSST (equities/managed futures). I'm on board with some TIPS exposure. There are plenty of sophisticated pools of capital that allocate to what they call inflation protection so not just TIPS and while there's probably no guessing what inflation might do precisely over the next long period of time, it is a good bet that it doesn't go sub-1% anytime soon if ever.
Just like 50 is the new 35, could 80/20 be the new 60/40? Not really 80/20 but 80% in equities and 20% in alts that avoid interest risk and fixed income volatility that do a better job offsetting equity volatility.
This is just a different way to articulate the same point we've been making for over a year now. The study is only four years because it was some time in there where bonds stopped being a one way trade and turned into what I've been calling a source of unreliable volatility. If you go back to 2012, BTAL's inception, Portfolio 2's outperformance narrows to 249 basis points and the standard deviation is higher than Portfolio 1's by 44 basis points which is actually pretty close.
And this is the comparison since the start of the bond bear market from the start of 2022.
If you've been reading this site for a while you might recall I am not a fan of 20% allocations to just one alt so that's not what this is about. It's about understanding the efficiency that holdings like BTAL (personal and client holding), there are others too, can add to portfolio that has better diversification than 80% in one name and 20 in another. These holdings tend to go up more when stock drop so they potentially offset more equity volatility than bonds do. Arguably, bonds didn't offset any equity volatility last year. The reason to avoid 20% in something even if you have unyielding faith in it, nothing should be thought of as infallible.
I've always believed this sort of work is important to do, I've been at it a decently long time and will continue to try to evolve with the space, trying to avoid risks that are waiting to turn into ugly market events like we've been seeing play out in the bond market since late 2021.
The information, analysis and opinions expressed herein reflect our judgment and opinions as of the date of writing and are subject to change at any time without notice. They are not intended to constitute legal, tax, securities or investment advice or a recommended course of action in any given situation.
