First a followup to yesterday's post about return stacking and the notion of the free 10% that Corey isolated in his blog post. Underpinning what ReturnStacked ETFs are trying to offer is a way to add alternative strategies to a portfolio without having to shave off a little equity or bond exposure or shave off exposure to both in order to make room for whatever alt someone might want to add.
Used in a manner like we described yesterday or other approaches, the portfolio can maintain its 60/40 stocks/bonds mix and then "add alternatives on top" is how I think I've heard them describe it. By maintaining the 60/40, the portfolio avoids tracking error. You've got the 60/40 in there by way of a capital efficient fund so no tracking error as they view it. The alt then give the chance to add some sort of effect with adding alpha or reducing volatility as the most common objectives.
I'm pretty sure that sums up their position. Two points from me. I'm not sure that the thing they are trying to avoid, tracking error, actually needs to be avoided. If the objective is looking like the benchmark for the most part and then reducing volatility, then I think you don't really need the leverage. If you're trying to outperform on the upside, it still comes down to picking the right thing. Try to add alpha with Nvidia (NVDA) and you'd have had good luck over the last couple of years regardless of sizing and regardless of whether your return stacked or not. If you tried to add alpha with Bank of America (BAC) then you've had bad luck over the last couple of years regardless of sizing and regardless of whether you return stacked or not.
Where they are talking about alts, some alts are pretty reliable like client and personal holding BTAL which reduces volatility in what seems like every instance and managed futures which usually does, even if not quite as reliably as BTAL.
You really need to choose carefully with some alts and accept what they are trying to do or don't use them. Merger arbitrage is not going to contribute to outperformance to the upside. I have faith in it lowering volatility but zero expectation of adding basis points in an up year.
With all the options related ETFs that have hit the market lately, here is another idea that I bet someone will ETF. This comes via Marketwatch and something called the CBOE Dispersion Index. The idea is to go long volatility of individual stocks and short volatility of indexes in a sort of spread trade. I found the chart on Google Finance.
A spread-type of strategy should be less volatile than the underlying and that has been the case so far for DSPX but it is still very new. I am curious enough about it to try to learn more including what could go wrong with this sort of spread trade. I also threw in client holding PPFIX onto the chart which might be the least volatile fund that sells.....ahem...volatility.
Volatility as an asset class is fascinating to me for there being a wide range of how to use it ranging from incendiary risk shorting the close to the money VIX to covered calls which is not something that can end in catastrophe but can get left far behind in a bull market. For what it is worth, I have previously described PPFIX as picking up pennies a mile and a half in front of the steamroller. It sells puts that are very, very far out of the money.
There can be a place for small exposure to certain volatility strategies but these are not simple and have risks that have to be understood before going in. I just mentioned the risk of covered call funds. Look at XYLD and QYLD, both from Global X and have been around for a long time. Like I mentioned, this strategy can get left far behind and these two seem to fit that bill exactly. That's not bad or good, that's the tradeoff.
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