Differentiated Return Streams

We spend a lot of time here dissecting alternatives in pursuit of refining the portfolio to being more resilient in the face of serious declines and trying to improve risk adjusted results. One high level aspect of this process is trying to understand what to expect from a particular fund. For some funds it is easy to figure out what it is trying to do, regardless of whether it succeeds, you can figure out what the goal is.

Some funds are more difficult to figure out. One that puzzled me for its short time was the Noble Absolute Return Fund (NOPE). Here's a chart from a blog post that mentioned it back on April 5.

Absolute return typically implies some sort of low vol outcome where it will go up a lot less when stocks are rally hard and will be flat or maybe up a little when stocks have a big drop. It came out like a fire cracker showing enormous swings in both directions. Then it appears something in the strategy changed, it traded with a slight downward tilt before closing. There was no way to model something like that into a portfolio. Despite the volatility, it was not an asymmetric opportunity like Bitcoin or maybe uranium. I tried but could never figure it out. 

Contrast that with something like merger arbitrage or convertible arbitrage. Those two are examples of what I call horizontal lines that tilt upwards slightly. I believe them to be very reliable in this regard. There are others we've looked at that should have a negative correlation to equities that also deliver on that expectation. 

Not only am I trying to understand the expectation that I think is being set, I think there needs to be some reasonable basis to expect it can meet that expectation. We've looked at several funds from Simplify where the expectation seemed easy to understand but just didn't execute including its failed tail risk fund and the Simplify US Equity PLUS Downside Convexity ETF (SPD) which owns the S&P 500 with a put option overlay for protection. In 2022 SPD was down 25.96% versus 18.19% for the Vanguard S&P 500 ETF (VOO). 

All of that brings us to the Unlimited HFND Multi-Strategy Return Tracker (HFND). It bundles long/short equity, global macro, event driven, fixed income arbitrage, emerging markets and managed futures into a replication product. It's managed by Bob Elliott who having heard him speak many times, I believe he knows his stuff. 

Per an email from Unlimited the fund is trying to offer "core, liquid, uncorrelated ballast within overall asset allocation." It's only been trading since late 2022. 

The expectation is easy to understand but should we have basis to expect it can do what it is trying to do? So far, the answer is no but there hasn't really been a test yet. The fund is actively managed so it could look much different when the next big decline comes and maybe it will do fantastically well but for now there is no way to know. It has a 0.87 correlation to VOO and a 0.89 correlation to VBAIX. They would probably argue that since inception, it has made sense to have a high correlation to VOO and VBAIX and they'd be right. Some strategies it clicks right away that it will work as advertised with client/personal holdings BTAL and BLNDX being examples but HFND needs to show it can differentiate. 

Another example of an interesting fund still needs to prove it works is the Alpha Architect Tail Risk ETF (CAOS). Tail risk has proven difficult to package into a fund. I mentioned the Simplify fund that failed. The Cambria Tail Risk fund lost a lot of ground from holding longer dated treasuries and the erosion of the puts the fund owns. CAOS has it's cash in very short term instruments to hopefully avoid interest rate risk and instead of simple put exposure it combines puts and calls in such a way that so far has been additive versus T-bills since its inception. CAOS did have noticeable dip in April of this year though. 

A slice in CAOS certainly has not hurt returns but during the shallow decline you see on the back test from August 2023-November 2023, CAOS was down a few basis points. Obviously it didn't hurt returns or make that dip worse but it did not go up as 60/40 dropped about 5%. Where it is a tail risk strategy, it might only "work" when there are big declines as opposed to gradual dips. 

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.