Portfolio Construction & 20% Yields

A few interesting things from here and there on the interwebs.

First up was a webinar about model portfolios at ETF.com. This first little bit might be more for advisors but the topic is interesting. They talked about how outsourcing model construction can save advisors a lot of time. That is probably true. The way my new firm is set up, I could outsource everything, for a fee, and the way this was positioned, I think there might be a decent number of advisors who do just that. The idea that I could do no work is culturally acceptable. I outsource compliance (have to), technology stuff (pretty sure I have to) and we brought our support person with us to help with things like RMDs, money movement and other administrative work. Outsourcing the work related to actually being an advisor would not feel right to me and I enjoy what I get to do including portfolio construction.

A model portfolio is simply a portfolio that can scale up to be implemented in sort of an automated fashion across the board for all clients or maybe an advisor will have a stable of a couple of different ones they use depending on a client's particulars. The webinar talked about the future of model portfolios transitioning from a combo of ETFs for passive and mutual funds for active to include more direct indexing to allow for "tax optimization." Similar to ESG, I think direct indexing will turn out to be a fizzled out idea that doesn't gain real traction. If that turns out to be wrong so be it, but it seems like a gross over complication even if it can be automated. 

I think that when investors hear about model portfolios they sort of think in terms of set and forget. Correct me if that is wrong. Model portfolios make sense (I'm just not a fan of outsourcing the work), I think most advisors who construct their own portfolios have a tremendous amount of overlap across the board that is tweaked a little bit, again, based on a client's particulars. 

The one word that was missing from the webinar, although it was very edited, was simplification. Set and forget is a very bad idea, markets can be very dynamic at times and some rebalancing needs to occur every now and then, even if not arbitrarily based on the calendar. Set it, monitor it and adjust when called for. That requires an active engagement which doesn't preclude having a nice simple portfolio and does not require active/frequent trading. 

John Authors took a jab at CALPERs, piling on with Meb Faber. This is an idea we've explored before too. The high level take away is that for all the time and money CALPERs spends, they are not generating any extra return. As Authors notes, the returns are not bad but they are not good. The returns are fine, pretty close to what they could get, by Meb's work, with a very simple ETF portfolio. This is good reminder about the stock market's ergodicity, the market's tendency to work higher. Over longer periods, the stock market will move from the lower left to the upper right at some annualized rate of return. That rate of return, whatever it turns out to be, plus your adequate savings rate should be enough to get to where you want/need to be or at least get you close. 

Stocks are going to go up. The more effort you expend, like frequent trading or in CALPERs case, frequent policy changes, the more you're are fighting against the market's ergodic potential. That's not a call to do nothing. Asset allocation matters. Putting in a little work to make sure you don't succumb to panic matters. But there is a fine line between maintaining the proper portfolio for your situation versus fighting the market's tendency to work higher. Know the difference and let the market do most of the work. 

Return stacking thought leader Corey Hoffstein had an interesting paper looking at how to replicate TIPS exposure. Before the paper came out he Tweeted a rhetorical question, what are TIPS if not treasuries with commodities stacked on top. It's an interesting question. Commodities generally provide protection against inflation even though sometimes it's a little more complicated that that.  

Corey weaves through to stacking managed futures on top of bonds because managed futures can protect against inflation (it is long/short commodities), Corey notes commodities have a higher beta to inflation which makes intuitive sense, and can protect against deflation by his reckoning, he says there is historical data to back that up. Corey is part of the team that managed the Return Stacked Bonds and Managed Futures ETF (RSBT). Each dollar invested in the fund gives $1 dollar of exposure to bonds and $1 of managed futures, exactly what the paper is about but I do believe Corey to be an honest actor.

So let's see how the idea backtests with a leveraged version, and an unleveraged version against the iShares TIPS Bond ETF (TIP).

And the result. 

So the unleveraged version tracks closely to TIP but with a little more volatility. The leveraged version looks just like the unlevered but with larger moves in both directions. The idea is interesting but we're not actually tracking inflation, we're tracking TIPS which are I guess a derivative of inflation but as we saw last year, longer dated TIPS are vulnerable to interest rate risks. The TIP ETF when down in price as inflation went up. 

Here's an interesting chart.

NVDY is the Yield Max Nvidia ETF which owns the stock and sells covered calls. The yield on the whole suite of these is sky high. The chart is distorted for not capturing the NVDY dividend, just the price. The total from the monthly dividends thus far is $4.53. Based on an initial price for NVDY of $20, the $4.53 adds another 22.5% to the total return for anyone who bought when the fund first listed in May and just held on. So using simple math, the total return is 34% versus 72% for the common. 

We've talked some about covered calls lately. I just thought this was a good example to show that covered call funds probably won't keep up with the plain vanilla underlying when there are big price moves. I wouldn't call that a bad thing, that just an expectation that users of these products should have. Another example:

VOO is the Vanguard S&P 500 ETF, the plain vanilla index fund. XYLD has paid out $3.85 in dividends so far this year which based on where it started the year is just shy of a 10% yield so the total return of XYLD this year is about half the plain vanilla VOO. No matter what you own, it is important to have the right expectations. That true of plain vanilla and any sort of alternative product. 

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.