Models Gone Wild!

This post will start with a followup from yesterday's look at the apparent implosion of the Simplify Tail Risk Strategy ETF (CYA). It was down again on Tuesday, still trading well under a buck. The inception date for CYA was September 13, 2021.

Just over a year ago, summer 2022, I wrote a few blog posts about the Return Stacked 60/40 Absolute Return Index. The idea is to create a portfolio that has better risk adjusted returns using "sophisticated" funds with diversification ideas beyond simple stocks/bonds/cash and what they hope is prudent use of leverage embedding return stacking into the mix. 

As you can see from this image from a blog post in July, 2022, CYA had a 3% weighting. 

At some point along the way they shed CYA. The second image is live on the portfolio's website right now. I don't know exactly when this Absolute Return Index was constructed but by the time July 2022 had rolled around, CYA had a 10 month track record of doing nothing but going down.

This gets us to the point of today's post which is to not get too carried away with modeling portfolios, not to get too carried away with what appears to be very sophisticated ideas, tail risk is a sophisticated idea, and to think more critically when doing portfolio construction work.

I play around with stuff on Portfoliovisualizer all the time. It is interesting and fun for me but there is a potential trap there of being willing to dismiss things like very short time periods available to study with newer funds as well as projecting previous successes forward. It is important to recognize our personal weaknesses as we do this work. I've said many times that I am a sucker for a good story. They all sound good. Knowing this about myself makes it much easier to avoid bad decisions. Not that you won't make mistakes but making a mistake with 2-3% of your portfolio is a whole other thing than permanently impairing your portfolio with a 20% allocation to some intellectually appealing strategy that then blows up. 

The above comparison is a great example of what I'm talking about. Portfolio 3 is the Vanguard Balanced Index Fund (VBAIX) a proxy for a 60/40 portfolio. Portfolio 2 is just two alternative strategy funds weighted 70% and 30%, we'll leave the names out of it. They blend together to have a much higher CAGR, much lower standard deviation, far superior portfolio stats and appears to avoid interest rate risk.

That is a hell of a back test...so far as it goes, which is only 4 years (just shy actually) because of the newness of one of the funds. Only four years is strike one. It's only two funds which is strike two because if something unforeseen happens strategically with one of the two such that it cuts in half, the portfolio owner would be in real trouble. Putting 30% into one alternative strategy, let alone 70%, seems like a truly terrible decision waiting to hurt people. The period studied might be skewed by how terrible stock and bond markets both performed in 2022.

In the last year and half, I've seen all sorts of commentary and opinion arguing for huge weightings in managed futures. Just about all of the funds did fantastically well in 2022, enormous gains. I think it's a great strategy for being reliably, negatively correlated to equities. If I am right about it being reliably, negatively correlated to equities it's going to spend a lot of time not doing well. That was the case from shortly after the Financial Crisis until 2022 as stocks roared higher. I don't know why anyone would want 20-30% in a strategy that is negatively correlated to stocks, stocks being the thing that goes up the most, most of the time. I'm probably just under 5% in managed futures for clients. I'm a huge believer, less than 5%. 

One fund in the Absolute Return Index that we haven't talked about is NFDIX. That fund uses leverage to own 75% in equities and 75% in bonds. Portfolio 2 is what I believe to be a proper comparison and Portfolio 3 is just unleveraged 50/50 exposure. I may not understand NFDIX properly but the track record is really bad. The idea sounds smart to me but it somehow gets lost in the implementation. If I spent time trying to figure it out I don't know that I could.

There is balance to this whole process of being curious and open-minded but also knowing how to be skeptical. 

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