Cliff (and Meb) Notes

Meb Faber interviewed Cliff Asness in a podcast format. There was plenty of great stuff of course, this post covers some points made that stood to me as worth expanding on and exploring.  

They talked about when a potential investor, the context is a large institutional investor, talks about investing a small amount to see how it does for a while. Both Cliff and Meb agreed that whatever this person has in mind for "does for a while" is going to be too short a timeframe to draw any useful conclusion. This is along the lines of what Ken French has said in this regard, that one year is not enough time, three years, maybe even five years is not enough time to assess a fund or strategy in this context. 

I partially agree but there is a different take to consider. Certainly, a few months to draw a solid conclusion about some sort of long only, better returns than the market strategy is too short a time. Value has lagged for ages. I wouldn't necessarily expect a value fund/strategy to outperform market cap weighting (MCW) when value in general is far behind MCW and growth too for that matter. It could happen of course but not a realistic expectation. 

Occasionally I will mention that I am test-driving a fund for possible inclusion in my practice. Right now I am test driving QQQY and ISPY. I've had QQQY for almost seven months have haven't concluded anything. Defiance who runs QQQY set an expectation that they believed it would trade like a covered call fund. So far, that is pretty close but there has not been a drawdown large enough to expose whether its strategy could have a problem. I'm content to hold it and reinvest the dividend. Similarly with ISPY, the hope with this one is it tracks much closer to the MCW S&P 500 than covered call funds that sell monthly calls, and do so with a much higher yield the MCW. After not quite four months, I don't yet know if it will do what I hope. Nothing bad has happened but too soon to draw a firm conclusion.

The thing I am looking for with this is to understand what expectation the fund company is setting for a fund, like I mentioned above with QQQY, and then whether the fund can meet that expectation. One fund that has since closed that I said I didn't understand the expectation being set was the Noble Absolute Return Fund which traded with symbol NOPE. I said a couple of times that I had no idea what the fund was trying to do. Those first few months it looked nothing like an absolute return, then it did but drifted lower and finally closed. This sort of result is a useful example of a fund not meeting expectations.

Later on in the podcast, Cliff made a comment so brief it was almost in passing, about the combination of trend and carry being a very good portfolio combination. The word momentum was included here so I built the following.

Portfolio 1 is 100% to Vanguard Balanced Index Fund (VBAIX) which is a proxy for a 60/40 portfolio. There used to be a currency carry trade ETF but I can't find it anywhere now so maybe it closed. Portfolio 2 goes long the Aussie dollar and short the yen which is one version of a carry trade. Portfolio 3 uses Vanguard Market Neutral as a substitute for carry and you can decide if it works or not. 

The pursuit here is whether we can create a proxy for a 60/40 portfolio that avoids interest rate risk and the increased volatility that intermediate and longer term bonds have had lately and I believe still do have.

As is the case with many of the portfolios we build in this context, the momentum, trend and carry portfolio tracks 60/40 until 2022. Portfolio 2 was down 69 basis points in 2022 and Portfolio 3 was up 1.99% that year. 

Toward the end of the podcast they tried to pin a number on how much should be allocated to alternatives. The conversation sort of drifted to a number which I will get to in a moment. By Cliff's reckoning, if you do the spreadsheet work, you would find that the optimal strategy is to pretty much do the typical thing with stocks and bonds and then leverage up a lot to add alternatives on top which of course sounds a lot like what the ReturnStacked ETFs do. 

I think Meb generally agreed but they both conceded that most investors aren't going to do that. They drifted into 20-25% being a realistic number even if not optimal. Cliff said that only doing half of what is optimal and sticking to it is better than going to the full optimal amount but not sticking with it and by extension, I would say going halfway in is better than nothing. To be clear, I don't think they were implying 40-50% is optimal.

A realistic way to implement 20-25% to alts in my estimation is when you have small slices to several strategies that mostly replace longer duration fixed income. We've written countless posts about ways to use alts in this manner to allow for increasing equity exposure but reducing volatility versus 60/40 and avoiding the full brunt of large declines. 

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