Just Because You Can, Doesn't Mean You Should

Portfolio replication is a tricky thing that frequently doesn't work. It can work like with the now closed Alpha Clone ETF. It replicated hedge funds based on stale 13-f data but it worked. The fund must not have gained enough AUM to last but it did work. 

We look at a lot of different ideas here, whether we are talking about replication or not, not to simply copy what someone else is doing but to see if some random strategy might have some piece of process or an idea to incorporate in a way that adds value to our portfolio. It's fascinating work and a lot of fun which brings us to an interview from earlier this month of Jason Buck from Mutiny Funds, proprietor of the Cockroach Portfolio, he was interviewed by blogger Nomadic Samuel. 

To run the Cockroach, Buck appears to function as the asset allocator and then a manager of managers. It seems like a fund of funds but not in funds that are exchange traded or otherwise available to retail brokerage investors. A point from the recent interview that I don't think I picked up on before is that the Cockroach is levered up as follows.

• Global Stocks 50%
• Global Bond 50%
• Long Volatility 50%
• Commodity Trend (managed futures) 50%
• Fiat Hedges (gold, bitcoin, ethereum) 20%

First we can look at this leveraged version with bitcoin and one without using retail accessible products and compare that to the Vanguard Balanced Index Fund (VBAIX) which is a proxy for a 60/40 portfolio.

Portfolio 3 is 100% VBAIX.

The 2% in bitcoin was very noticeable which is a nice anecdote for my belief that small allocations to diversifiers can go a long way.  

Portfolio 1 has a decent CAGR, maybe better than decent but the standard deviation is very high and the Sharpe Ratio is no great shakes either. It would get the job done but it would be a volatile ride. There is also the issue of figuring out how to leverage up the way Portfolio 1 and 2 do in a normal brokerage account, it's too much leverage for margin unless you have a large SMA (is SMA still a thing, I've been out of that world for more than 20 years?). Again the difference in performance between 1 and 2 is the 2% weighting to GBTC.

If you're curious, an unleveraged version of Portfolio 1 had a CAGR of 5.22% and a standard deviation of 8.09%. A CAGR of 5.22% could get it done for someone is close to or already in the game over camp. 

I wanted to take another stab at building a Cockroach-inspired portfolio, building in volatility and trend which I do use in actual client accounts in much smaller proportions and bitcoin which I don't include in client accounts.

The weightings to the diversifiers are nowhere near as high as in Cockroach because as noted above, a little bit can go a long way. 

Portfolio 2, Cockroach-inspired, allocates a lot more to equities. The alts allow for what I have been calling leveraging down, increasing the equity exposure and offsetting with allocations to strategies that I think are reliably negatively correlated to equities.

The inspired portfolio has a much higher CAGR, much lower standard deviation and no actual leverage. It is crucial to understand that the portfolio that Jason runs has far more moving parts which you can see if you click through to the interview. Reviewing managers and evaluating for possible changes is a full time job. It was not mentioned but I will assume that the returns and volatility measures for the thing Jason actually manages are far superior to the thing I concocted which is the point made above. Replicating these things, actually trying to implement as we read about them, will often not be ideal.

I want to be clear that I don't think trying to implement Jason's portfolio with retail-accessible products is a good idea, full stop. But something kind of interesting is that sort of contrary to what I said above, I think there are ways to kind of recreate the leverage or at least get close with some of the various capital efficient funds out there or that are coming. Again, it is more interesting that the leverage could be replicated, not that I have in interest in doing it, I really don't think it is a good idea. It fits the bill as I've described in the past of a portfolio of diversifiers hedged with a little bit of equity. 

 

	Allocation	Equity	Bond	Trend	Volatility	Gold	Bitcoin
RSSB	33	33	33
BLNDX	17	17		34
RSBT	17		17	17
UVIX	25				50
SHNY	6					18
GBTC	2						2
	100	50	50	51	50	18	2

The reason I say kind of in that last paragraph is that some of these funds are too new to know if they will really work. Here come the caveats.

RSSB is not out yet. If it comes, it will be 100/100 global stocks and bonds

BLNDX can be 50/100 stocks and managed futures but they can also dial back the managed futures too

RSBT is 100/100 bonds and managed futures, it is too new to know if it will work and based on NFDIX, I have concerns about the implementation and it is down about 14% since it launched in February

UVIX is 2x short term VIX. It's one of these down 99% VIX products, you'd be setting money on fire. 25%? Get out of here with that.

SHNY is a 3x gold ETN. Maybe it will look like 3x GLD or maybe it won't look anything like 3x GLD, there's no way to know. 

GBTC it might end up being magic internet money and go to zero, I am still on board with a small asymmetric bet in the right circumstance. I stuck with GBTC for the blog post because it has the longest track record for backtesting.

Just because you can do something doesn't mean you should but the whole exercise reiterates a point I started making 19 years ago that ETFs will continue to evolve to allow for more and more sophisticated portfolio implementations. Things like volatility, trend and the leverage some of these funds use are sophisticated concepts I just don't love the execution yet.

BLNDX, VIXM, MERFX, BTAL are client and personal holdings. 

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.