Orthogonality On Steroids

Jared Dillian had a fascinating blog post titled The Life Hedge. Dillian is fairly well known in FinTwit. He spent time at Lehman Brothers, then was/is affiliated with John Mauldin and does other writing too. He has some unique ideas that are often very thought provoking. 

The post starts with looking at a scenario where an economic downturn occurs and someone gets laid off from their job while their investment portfolio gets cut in half. That's a double whammy and Jared points out the potentially high correlation to job loss and a meaningful decline in the stock market. This is very stressful he says and that 99% of country lives that way meaning high correlation between their job and investment account. There may never be a consequence for the risk of that high correlation but the risk is there is his point. 

Jared goes out of his way to not live with that overhang. He says his portfolio is constructed "in such a way that it might limp along or be flat during expansion, but explode higher during recessions." It is high on his priority list to be counter to the US cycle or as we've put it before, he wants to be orthogonal to US cyclicality. He goes into some detail on how he does this including having put options kind of like a tail risk fund of which there are a couple, he is also short US equities to a small extent and also long gold and other commodities. He says he is "diversified in ways you cannot imagine, across the world, in various asset classes."

A big part of his being able to do this emotionally is that he has trained himself to have no sense of missing out when US equities are going up which as we talk about all the time, they do far more often than not. He gives a nod to just being in cash right now which at 5% is more compelling that it has been in years. That's far behind what equities have been doing but 5% on cash is pretty good. 

Jared thinks his returns are about keeping up with the S&P 500 without obviously being long US markets. I am not doubting him but I tried to recreate a portfolio that kept up with the S&P 500 while being short the US and I couldn't find a way to get there. This makes me think there might be a lot of trading on his part or some outstanding stock selection. For example, if he has a basket of stocks doing as well as client holding Novo Nordisk (NVO) along with some Bitcoin while being short the S&P, then yes, he could be keeping up or doing better. The point is it would be tough to recreate his result just using broad based funds and a couple of alts but that doesn't mean we won't try.

I built the following three portfolios that I think come close to what he is describing but the results are nowhere close to the S&P 500. The portfolios are similar, but with tweaks and a couple of them include Bitcoin exposure which it seems plausible he'd own.

Portfolio 1

Portfolio 2

Portfolio 3

If someone had an interest in being net short US equities, I think client and personal holding BTAL would be better than things like the ProShares Short S&P 500 (SH) or the AdvisorShares Ranger Equity Bear ETF (HDGE) which both compound very negatively over the longer term whereas BTAL actually compounds positively by just a few basis points. 

The results

A quick note, Portfoliovisualizer totally overhauled its interface and I am still trying to figure it out. All three compounded positively over a decent number of years so that alone is a little surprising but they are far behind the S&P 500 Index which compounded at 12.1% for the same period. Whether coincidence or not, all three portfolios had higher returns, mostly, as inflation started to pick up in the last couple of years or so including being up close to 10% in 2022. They might then accomplish a version of Dillian's desire to be counter cyclical.

It is not clear to me why too many people would need to go to this extreme but it is a fascinating concept. He touches on an idea I first mentioned before the financial crisis about the fact that investment professionals are very exposed to the ups and downs of the markets. This is something Meb Faber talks about regularly as well. All investment professionals are levered to the ups and downs of markets. Their business and their own money potentially. My answer has always been to simply have a smaller allocation to US equities than most people and to use alternatives to greatly reduce the volatility of my bottom line number which allows me to not sweat the occasional large declines in markets. In addition to preferring to not be stressed out, the last thing clients need is for their advisor to be obsessed with their own portfolio at the expense of time and energy devoted to client assets. 

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