Monday, January 22, 2024

Minimizing The Damage Of Large, Unexpected Withdrawals

Here's an interesting Tweet and yes, I am sticking with calling it Twitter/Tweets.


The concept is important for understanding why short sale bans are a bad idea. There is a secondary, more subtle point that relates to portfolio construction and portfolio theory as we discuss here and as I have implemented into client accounts. 

Back in 2006 and 2007 there were far fewer funds available to help offset large stock market declines. Basically 1x and 2x inverse funds and the hope that gold would maintain its negative correlation in the face of a large decline. I wrote plenty about inverse funds and gold back then and used inverse funds in the Financial Crisis and they helped. I also had gold (added managed futures a little later) and it too helped somewhat. 

Part of how I described them in blog posts and explained them to clients back then was that they should go up when markets go down. The more the portfolio went down, the more the inverse fund would grow to hedge more of the portfolio. I did some selling as the market was starting to breach its 200 day moving average but I also relied on inverse funds doing their thing. 

The way the world has evolved in terms of my thought process and different types of negatively correlated products that are now available, I really don't need to sell much to get defensive, I can rely on the various negatively correlated alts in my ownership universe as well as the alts that tend to be more absolute return no matter what is going on to help manage bottom line volatility. 


Above is a good example of what I mean from the Pandemic Crash in 2020. When the S&P 500 was down just over 30% in late March, client and personal holding BTAL was up 9.69%. From the standpoint of realizing how difficult it is to capture fast turns in the market, maintaining a position in something like BTAL will dynamically reduce net long exposure (the point made in the Tweet) for you during market drawdowns. 

If instead of bottoming out with what I think was a 33% decline, if it had instead been a 43% decline, then BTAL would have helped more by virtue of growing into a larger weight of the portfolio. Knowing when to reduce equity exposure by selling is much harder to do than just letting an alt or two do the work for you.

Another portfolio management benefit comes if a client has an unexpected, relatively large cash need which happens every so often. In a grossly oversimplified example, let's consider an account that starts on January 1, 2020 with 75% Vanguard S&P 500 ETF (VOO) and 25% BTAL. Three months later, at the low an emergency pops up and the client needs to take 10% of their account out. If that was you, would you rather sell VOO after a panic while it is still down or sell BTAL which was up a lot. After a large decline there is less need to protect against a large decline. It already happened. Sell the BTAL and avoid permanently impairing your capital.

If we're talking about a taxable account then maybe you sell a little of both in some sort of ratio to either eliminate a capital gain or at least minimize it if appropriate. 

There are plenty of scenarios where someone might be a forced seller of equities and invariably the timing is bad with regard to what is happening in markets as opposed to "hey, my portfolio hit an all-time high today and I need to take out $35,000 for some emergency" which I can tell you, it never works out that way.

Repeated for emphasis, in addition to any cash set aside for managing sequence of return risk, being able to draw from alts that go up a lot when stocks drop or alts and fixed income with no volatility should greatly reduce the negative impact of a large, urgent withdrawal.

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.

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