ETF Odds n Ends

After having fun the other day with building a 75/50 portfolio with just two or three funds, I wanted to start this post a little more practically with portfolio construction and the importance of diversifying your diversifiers. My thought on why this is important is very simple. No diversifier should be expected to work all of the time, during every market calamity. I would not bet on being able to predict which diversifier might disappoint in the next market event. 

Both portfolios have 80% in Vanguard S&P 500 ETF (VOO) and you can see in the graphic where the other 20% is allocated. Both PPFIX and JAAA are in my ownership universe. They don't track identically but are quite close, offering what I'd say is the same effect but using completely different strategies. PPFIX sells index puts that are very far out of the money and JAAA owns collateralized loan obligations, CLOs not CDOs. 

It's not a reasonable worry that some freak event that derailed CLOs would hurt the strategy used by PPFIX and vice versa. I'm not saying impossible, it just is not a realistic concern. So it is with other types of diversifiers. The two above have very little volatility and are not negatively correlated to equities, they are more like absolute return. I'm also a huge believer in maintaining exposure to diversifiers that are negatively correlated to stocks. They offer a different kind of protection but I think there is potentially more that can go wrong with negatively correlated strategies which makes diversifying them arguably more important. 

If someone wants 2-3% in a negatively correlated strategy, then I don't think that needs more than one fund but at some percentage, determined by the end user, a second or third fund becomes important. For the purposed of modeling in blog posts I put 20% in things like client and personal holding BTAL or managed futures but in real life it is no where close to that. I say that regularly but it is worth repeating. 

Circling back to the Alpha Architect Tail Risk ETF (CAOS) from earlier in the fall. I've been critical of the fund. It hasn't been around very long but in its short time it doesn't seem like it has actually offered downside protection. If anything, it seems slightly positively correlated to stocks.

As I understand the strategy, it mostly owns BOX spreads or the BOXX ETF, another Alpha Architect fund, with an options overlay that is like a volatility management program that should help mitigate broad market declines. CAOS is actively managed. Tail risk, generically is a money losing strategy until something blows up. The puts tend to expire worthless as markets go up. CAOS tries to offset that effect with what I called a volatility management program and thus far, you can see the result. 

A way to maybe think about CAOS is that perhaps it is really an absolute return vehicle and that anyone who owns it shouldn't expect much stock market protection. Then if it turns out that the puts do pay off all the better. Maybe the fund will prove my skepticism to be wrong. 

Grantham, Mayer & Van Otterloo jumped into the active ETF fray in November with the GMO US Quality ETF (QLTY). Barron's said the ETF uses a similar strategy as the GMO Quality Mutual Fund (GQLIX) which has outperformed its Morningstar category by 160 basis points annualized for the last ten years. It's not an ETF version of the same fund however which could turn out to be an important distinction. 

The fund has $15 million in AUM which might be seed money, I can't be sure. Despite the great track record GMO funds have, it seems like there isn't a whole lot of demand of stock picking ETFs with Cathie Woods' funds being a glaring exception. 

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