ETF Roundup & Strategy Study

Nouriel Roubini is jumping into the ETF industry with what will be the Atlas America ETF. It looks like it will be a multi-asset strategy to generate stable returns with low volatility and low correlation with downside protection thrown in there too. Roubini is great at laying out the prevailing bear case but if the next cataclysmic event doesn't come for years, the odds are pretty good that his fund will languish. Of course if the next calamity comes right after it launches the fund might do very well. I'm sure we'll have fun digging in if it ever comes but investing with a guy who built his reputation on being a permabear into a market that goes up the vast majority of the time doesn't seem like a great idea. 

Corey Hoffstein wrote a by popular demand paper on return stacking with gold. The article seemed to be more about the diversification benefits of gold, not so much leveraging up to include gold but I thought I'd put some numbers to the idea. First up is a version built around the WisdomTree US Efficient Core Fund (NTSX). This fund is leveraged up in such a way that a 67% allocation equals 100% into a fund like Vanguard Balanced Index Fund (VBAIX).

Obviously, to buy NTSX you have to want AGG-like bond exposure which I don't but it's fine for a blog post. I included gold of course as well as alts we talk about all the time with managed futures and client/personal holding BTAL. Both AQMIX and BTAL have a negative correlation to NTSX so in a way, this portfolio leverages down. 

We're able to backtest this for almost six years and you can the capital efficient portfolio with NTSX has a better CAGR with lower volatility. The capital efficient portfolio with NTSX outperformed 60/40 by 400 basis points in 2022 and was slightly better than 60/40 in every other year except 2023 when it lagged by 167 basis points. 

WisdomTree has another capital efficient fund that combines equities and gold to build around and compare. The allocations to VOO and GDE are very close to apples to apples of the NTSX portfolio.

This is a little closer to how I want to be allocated because TFLO as a fixed income fund avoids the duration taken with NTSX' AGG-like exposure.

The backtest is shorter due to when GDE started trading. The driver of returns for this comparison is avoiding fixed income duration. These both look compelling but there is no reason that gold and managed futures must be negatively correlated to equities. BTAL is the most reliable on this front but I would not assume it is infallible. Managed futures and gold certainly have the tendency to do well when stocks do poorly but the risk here is some event where all of them do poorly at the same time. If that instance were to ever occur, the leverage in the NTSX version would probably be more painful than the GDE version which uses much less leverage. 

A work colleague called me to ask about the Simplify Bitcoin Strategy PLUS Income ETF (MAXI). The fund pairs exposure to Bitcoin futures and generates income by selling option combos on index ETFs, commodity ETFs, treasury ETFs and actual index options on the S&P 500. I am test driving a small position in one of my accounts. 

It usually pays $0.15 per month in dividends which I have not been reinvesting but this month it paid out $1 which I did reinvest. The reason I am test driving it, is that it is not a covered call strategy that could cap any upside Bitcoin might have. It's more like a multistrategy fund that does a decent job of tracking Bitcoin that also benefits from selling the volatility of other types of assets. 

You can see it separated a little bit from the underlying in the last few months. I'm not sure if I think it is tracking close enough to actual Bitcoin. MAXI is up 38% on a total return basis versus 46% for Bitcoin. MAXI is a small part of my Bitcoin exposure, it's just a test drive. The real test of it will come the next time it cuts in half. Bitcoin could drop a ton without having any adverse effect on the markets it sells options combos on thanks to having no real correlation. So the option income could soften the blow of a sickening decline. 

One important note about MAXI is that other than a whopper $4.17 payout last December, every distribution has been labeled as a dividend including the current $1 payout so the fund may not be a good hold for a taxable account. It may not be a good hold for any account, that's what I am trying to figure out. 

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.

Everyone's Going After 'Boomer Candy'

Long/short is a category that can mean anything. All three of the following are different types of long short.

The Merger Fund is a client and personal holding. Keeping it simple, Invenomic swings for the fences, the AQR fund says it is "seeking equity like returns with less risk" and the Merger Fund is an absolute return vehicle. 

The correlations between them are pretty low other than between BIVIX and QLEIX.

Each of the three introduce different effects when combined with equity exposure.

The above are all 50% VOO 50% one of the long/short funds. BIVIX  was clearly the outperformer but as we've discussed before, the fund did phenomenally well in 2021 and 2022. The rest of the years look nothing like those two. I have no idea whether BIVIX can repeat those two years again but if it can't, then you have something that looks a lot like QLEIX with a lot more volatility. 

This is another example where the longer term result is pretty good for all three but the returns get quite lumpy from year to year. 

Blending all three equally with a 50% weighting to VOO yields an interesting result.

It has a much higher CAGR with less volatility. This is a good argument for diversifying your diversifiers.

ABR Dynamic Funds manages the ABR Absolute Convertible Arbitrage Fund (ARBIX). This is not in my ownership universe but I've referred to it for blogging purposes many times. This month, the managers wrote a letter going after one flavor of "boomer candy," buffer funds. 

My now standard disclaimer with buffer funds, is just don't. You can read their letter to learn more. This table was interesting though, it plainly lays some things out.

It shows what you're getting in terms of setting expectations...sort of. The letter only went into buffer funds, they never said what they were referring to as hedged equity. I am unfamiliar with "oldest collar fund" but they did say it goes back to the 1970's. And of course we talk all the time about the differences between the premium income category also know as derivative income funds and also covered call funds. 

Again, a couple of funds that seem similar based on their description that so far, in the short existence of ISPY do very different things versus the underlying. If the difference stands up, it is because XYLD sells close to the money calls that expire in a month which caps almost all the upside. ISPY sells close to the money calls for one day allowing for much more upside capture. ISPY is in my ownership universe. It's made a good impression for highish yield without being 60% and decent upcapture.

When you look at XYLD, you might think what about using it as a fixed income proxy? It dropped 12% in 2022, it fell 23% in the 2020 Pandemic Crash and it did just a little worse than the S&P 500 in 2018. Whatever XYLD is, what it isn't is a fixed income proxy.

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.

Endowment Style ETF

Cambria filed for the Endowment Style ETF (ENDW) which of course will be fun to look at and blog about. Cambria does a lot of interesting research and are committed to differentiated strategies in their product suite and ENDW would fit right into that description if it actually gets listed. 

It will be a fund of funds and it will leverage up. It's going to be actively managed but will target 60% in equities (30% in domestic and 30% in foreign), 30% in fixed income, 20% in real assets including REITs and 20% in "various hedge and trend strategies," presumably managed futures. It reads like there will be a value bias and a trend overlay in addition to the trend strategies mentioned already.

The above is a possible do-it-yourself version, I compared it to the Permanent Portfolio Fund (PRPFX) and the Vanguard Balanced Index Fund which is a proxy for a 60/40 portfolio.

There's not a ton of differentiation the way we replicated it but I'd give Cambria the benefit of the doubt to track it when/if it lists. In 2022, ENDW replication was down 13.60%, PRPFX was down 5.49% and VBAIX was down 16.87%. I used the iShares Aggregate Bond Index ETF (AGG) because Cambria has not been put off using AGG or similar products in other multi-asset funds. If we replace AGG with TFLO which is a floating rate fund, the CAGR goes up to 8.34%, the standard deviation goes down to 11.25% and the 2022 decline would have been 9.10%.

Someone wanting to mimic this but with more control over the constituents could use any of the various capital efficient funds to create the leverage effect. 

There are also the WisdomTree efficient core funds, aka the 90/60 funds that you could play around with to build your own version.

And a quick side note about the YieldMax ETFs which are the single stock ETFs with a covered call overlay that have very high yields. We talk all the time about the importance of reinvesting most if not all of the dividends from derivative income funds. YieldMax had a Tweet that touted the one year anniversary of some of its funds and included in the Tweet was the hashtag #drip as in dividend reinvestment plan so they are also telling shareholders to reinvest.

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.

What Happens To Your Social Security Payout If You're Forced To Retire Early?

If you haven't already, you'll soon get an email from the Social Security Administration telling you to create an ID.me account to access your Social Security statement and other info. I took it as a prompt to look at my numbers. 

When you look at your expected payout information it says the numbers assume you continue to earn what you made last year until age 67. You can change that assumption though. We frequently look at the extent to which people have their hand forced to retire or at least out of their primary career earlier than they were planning. It happens frequently and it is not easy to replace the lost income. I think finding work that pays a decent wage is a reasonable probability but far less so, finding a new job that pays as well as your old job. 

I've said many times, I plan to wait until 70 but will encourage my wife to take it at the same time as me which would be 64 and 2 months. If that all works out, we'd get my $4664 (in today's dollars) plus her $1496 which is half my age 64 benefit (she'd get a few dollars more for waiting the two months). If I die first, her $1496 goes away and she'd get my $4664.

We don't need to safeguard against things going exactly the way we plan for, we need to safeguard for things going wrong somehow. I cannot envision the scenario where I am not doing the same work I am doing now but I would have said the same thing two years ago right before the partners of my old firm got shut down (I was never a partner). 

What does going wrong reasonably look like for you? If I lost the income from my day job, we could get by but it would be uncomfortable at least emotionally whenever a big fix it came along. I've been cultivating incident management team work but only got out onto one fire so far this year. It's been a weird fire season in Arizona this year. We've had a lot of fires around the state but they've ended very quickly. There appears to be a lot more money for air resources than in previous seasons and the sequence has worked out such that there hasn't been much need for trainees in my position. Unless of course I screwed something up. The fires in other states are cooking pretty good but that might involve flying to an incident and I don't really have it dialed in yet to the point cutting what I take by 2/3rds versus loading up my truck with more than I probably need and driving.

All of that is a path to maybe two full two week assignments which would work out to about $25,000. If our earned income dropped to $25,000 in this context, we'd be in good shape financially thanks to Airbnb income but it would have a noticeable impact on our Social Security as follows.

An earned income of $25,000 would reduce my age 70 amount by $500/mo and my wife's age 64 and 2 months benefit by $134/mo. For reference you can compare the age 67 amounts in the two graphics, about a $340/mo haircut. 

If you're situation changed what might a replacement income be? The path to mine is plausible for the reasons I laid out even if there can be no assurances, I take nothing for granted. Maybe you have a very lucrative backup plan or maybe not but whatever it is, what is a reasonable income expectation? I could see myself in this sort of scenario taking more than the two assignments I mentioned above and if I really get my foot in the door (not there yet) I might sort of have to take more than two assignments.

The Social Security website does have some quirks to it but I think they are trying to provide information needed for planning and I think modeling in the possibility for a drop in income from late 50's/early 60's is worth doing. 

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.

What Problem Are They Trying To Solve?

Risk Parity has intrigued me since I first heard about it however many years ago. The very simplistic definition is weighting the assets by how much risk they have although I might argue the idea is more about weighting volatility than risk but either way. Often, in order to have the bond sleeve have the same risk (or volatility) as the equity sleeve, the bond sleeve would need to be leveraged up significantly. 

That relationship can and does change and various applications of the strategy incorporate more than just stocks and bonds and can be very sophisticated and/or complex. I've said many times that I don't think it works very well in a mutual fund or ETF wrapper but I find it worthwhile to study because we might be able to pull something useful from all the work the few funds in the space are doing even if we never use the funds themselves. 

AQR had a fund called Risk Parity which became the AQR Multi-Asset Fund (AQRIX) which does use some risk weighting in its process. There is also the WealthFront Risk Parity Fund (WFRPX) which is a Morningstar 1 Star fund that has really struggled, there is Risk Parity ETF (RPAR) and a leveraged up version of of RPAR that has symbol UPAR. The newest fund is the Fidelity Risk Parity Fund which has an alphabet soup of symbols but I'll use FAPYX. If you know of any others, please leave a comment. 

The first chart compares FAPYX to the others and I threw in Cambria Trinity which is a different type of multi-asset fund that is much simpler. Looking through to the holdings for FAPYX and AQRIX are fairly opaque due to how the various derivatives are labeled, it's tough to tell what they are and what the notional exposure is. And I was unable to find anything for WFRPX' holdings. Morningstar, Yahoo and even the Wealthfront page had nothing. If you have better luck, please leave a link in the comments. 

RPAR, being an ETF, has much better transparency. That fund only goes back to 2020 but I was able to rebuild it on Portfoliovisualizer and look back ten years. 

That's actually very close to in terms of year to year results of RPAR which does track an index.

Comparing the RPAR replication to a version that includes a little more equity exposure and to the Vanguard Balanced Index Fund (VBAIX) which is a proxy for a 60/40 portfolio.

And the year by year results.

The results are underwhelming. It's not robust in the face of adverse market extremes. Risk parity funds seem to do worse, certainly in 2018 and 2022. 

Now looking at AQRIX compared to RPAR replication and VBAIX. For the first five years, AQRIX was the old AQR Risk Parity Mutual Fund.

AQRIX appears to me to be a better mousetrap and it was far more resilient in 2022 but I believe it to be an inferior diversifier compared to some of the other alt strategies we've studied.

I've said before of risk parity, that I want it to work but where retail accessible funds are concerned it really doesn't work very well. Some of the other AQR funds have what I'd call risk parity influence and it works for them but even the AQRIX predecessor did not work very well. 

It seems like the dedicated risk parity funds are a solution in search of a problem.

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.

Are These ETFs Too Clever By Half?

Lots of ETF stuff today.

First, starting last fall, I walked everyone through my test drive of the Defiance NASDAQ 100 Enhanced Options Income Fund (QQQY). It sells 0dte puts on the NASDAQ 100 and generates a huge "dividend." On a price basis, the fund can't keep up with the payout, not even close. It came out last fall at about $20/share and today it is just under $14.00. The total return is a different story. 

For however many times I wrote about the fund, I made sure to mention that to own one of these, you need to reinvest most or all of the dividend. A 20% total return for 10 months is pretty good as is, say 15% if an investor took out something close to a normal dividend of 4-5% from the distributions and reinvested the rest. 

I could see a strategy blending QQQ with QQQY or a similar fund to capture more of the QQQ effect with just a little more yield. I backtested 90% QQQ/10% QQQY, it lagged QQQ slightly. Over the nine month backtest, that combo had a total return of 32.41% and yielded 5.5%. In that instance, I think an investor could rebalance a few shares out of QQQ into QQQY instead of reinvesting QQQY's dividend. 

Owning QQQY for five or six months, I reinvested each dividend, my total return was about 10% but the price in nominal terms fell from $20 to just under $16. The reason I am mentioning it today is that Yahoo reported the fund will be doing a 1 for 3 reverse split. There's a negative connotation with reverse splits and being associated with companies that come close to failing but I do not believe reverse splits the way QQQY is doing it is a negative unless an investor is spending the entire payout. If you have any interest in these, I can't stress enough how important it is to reinvest the vast majority of the "dividend" if not the whole thing. 

A quick follow up on the VettaFi fixed income webinar I mentioned yesterday. The angle for a bond substitute was the Cullen Enhanced Equity Income ETF (DIVP). I was not able to watch the entire thing. There was actually a program of different topics of which DIVP was one. DIVP looks like it owns value stocks that pay a growing dividend and sells call options. The ETF just started trading in March. There is a mutual fund version with symbol ENHNX that goes back to 2016. The mutual fund website compares the fund to the CBOE BuyWrite Index. 

The point I made yesterday is that equity funds, whether they are somehow defensive, high income, value, whatever, should not be expected to be substitutes for what people hope bonds will do. ENHNX fell 11% in the mini-crash at the end of 2018 and in the 2020 Pandemic Crash it fell 30%, both instances were a little better than the S&P 500 but not what I think investors expect from bonds. In 2022 it was up 86 basis points which good of course but also right in line with some other dividend fund including iShares Dividend Select (DVY) that we looked at yesterday that was up 1.91% in 2022. In 2023 ENHNX was up 96 basis points and this year it is up 29 basis points through the end of June. 

In terms we talked about yesterday, ENHNX is 1 for 3 as a bond substitute. Is that good enough? It might be a fine fund, I'm not saying otherwise but I would not count on it to be anything other than a lower volatility equity exposure and even then, not always. 

The real hook for the VettaFi event was Nancy Davis who runs the Quadratic Interest Rate Volatility & Inflation Hedge ETF (IVOL). I missed her part but can catch the replay when that gets emailed out. I was able to get a whitepaper about the fund that I dove in on. It's a complex strategy with a lot of moving parts. It has pretty solid AUM of $651 million but I am pretty sure it was over $1 billion at one point. 

It did very well in 2020 but other than that it has struggled. The oversimplified explanation of what it does is that owns TIPS via the Schwab US TIPS ETF (SCHP) and options such that it benefits from bond market volatility. SCHP has an effective duration of 6.5 years.

The following table paints a great picture of what environments are likely to be tailwinds for the fund and headwinds.

The whitepaper then goes on to position why the various, potential tailwinds could soon be coming into play. We've had plenty of interest rate volatility over the last few years as measured by the MOVE Index and the fund has struggled so maybe that one is less important. We know in 2020 that interest rates at the front end went down because of the Pandemic. SCHP went up almost 10% in 2020 which was more about rates dropping (bond prices up) as opposed to TIPS par value adjustments because the Pandemic was more deflationary than inflationary. The CPI was up 1.2% in 2020. Interest rates went down in 2020, the US Ten Year Treasury went from 1.83% to 1.11%.

The whitepaper suggests that if you want to add IVOL to you portfolio that you consider it as a replacement for part of exposure to AGG or TIPS.

There's no differentiation looking back. I guess if the curve steepens meaningfully, IVOL will outperform but that isn't clear to me. I don't have perfect understanding of IVOL by any means but one conclusion I draw is that there is not a direct cause and effect between the inputs and how the fund will perform. For example, a simple inverse index fund is a direct cause and effect. If the S&P 500 drops 1% today, the inverse will go up 1%, direct cause and effect, you know what you're getting. Client and personal holding BTAL is one step removed from that direct effect. It's almost as certain as an inverse fund. A fund that goes long the VIX index is pretty reliable but I believe less reliable than BTAL. I'm describing a scale or a spectrum. 

Not every alternative I use is at the same point on this scale of reliability but I think there needs to be some basis to believe the fund will be additive in some way. Something with a negative correlation is additive. Something that goes up slightly, no matter what is additive. Something that does it's own thing but generally makes it's way higher (I think this describes most of the AQR funds) is additive. I am not seeing it with IVOL. It seems like it could have a couple of the top down tailwinds happening and still the fund might not do well. It's like one or two variables removed from "working." Whatever an investor might hope to accomplish with IVOL can probably be found with a more reliable strategy/fund. Please leave a comment if you draw a different conclusion.

Last one, the Simplify Volatility Premium ETF (SVOL) got a 5 Star rating from Morningstar. I don't think I've ever looked at the fund but maybe I'm missing something. There's a 13 minute video to watch to learn about the fund. It has more going on under the hood than IVOL. I'd say it really is a hedge fund of sorts. It has about 30% in Simplify's own fixed income ETFs which each have their own complexities. SVOL also shorts VIX to capture between 2/10's and 3/10's of the VIX' movements. It does this by shorting VIX futures and hedging that exposure with long VIX calls. It also blends in S&P 500 options, mostly long puts, short some T-bond futures and owns some T-bills. 

The VIX seems to be the main thing but embedded into the VIX strategy is a carry strategy, there's that word again, to take advantage of the VIX futures term structure. The fund gives off a good amount of income as well. 

Simplify suggests making room for SVOL in the equity sleeve of the portfolio. So let's model that out.

Not much differentiation. Using 10% SVOL offered a little improvement in 2022, you can decide if you think that was meaningful. One other thing to point out is that it pays out a big "yield." The backtest shows total return. On a price basis it is down from $25.75 when it first started trading to $22.30 at the close on Thursday. Portfoliovisualizer says the correlation of SVOL to the Vanguard S&P 500 ETF is 0.82 which is high. They're saying it is an equity proxy and that seems to be true.

Comparing them one on one is interesting though.

There is some differentiation there. SVOL has a much lower standard deviation on the way to an identical return through the end of June. The portfolio above with 10% in SVOL, I reran it with 20% to SVOL and just 40% to VOO. The difference in CAGRs was one basis point but the standard deviation for 20/40/40 was 158 basis points lower and in 2022 the 20/40/40 blend outperformed straight 60/40 by 297 basis points. 

I feel like we've looked at countless other ways that do a better job than SVOL to create a more robust portfolio. Additionally, SVOL is very complex, there are a lot of things under the hood that can go wrong. Some of the other alts we've looked at have shown that smaller allocations have a greater observable impact on the portfolio than even 20% to SVOL. At 0.82 correlation to VOO, SVOL is not a differentiated return stream to the extent we've looked at in previous posts.

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.

Don't Hedge Equities With Equities

A few days ago I bagged on a strategist from Vanguard for telling investors to stick with bonds in a 60/40 portfolio allocation. In that post we put together a 60/10/10/10/10 portfolio with just 10% to bonds and the other 10% sleeves into different alts that each represented uncorrelated return streams. I modeled the strategist's idea for mixing domestic and foreign equities and bonds and also incorporated his idea into our comparison portfolio. We had a small issue being unable to backtest Vanguard Total World Bond (BNDW). A reader left a comment with a work around combining BND and BNDW so I reran it and compared it to 60/10/10/10/10 as follows going back ten years.

And an updated 60/10/10/10/10.

I swapped in the Merger Fund because it backtests a full ten years versus Absolute Convertible Arbitrage which only goes back to 2017. I also took out AQR Alternative Style Premia Fund (QSPIX) because of how poorly it did for four years leading into 2022 and then its monstrous gain in 2022. That sort of unpredictable volatility doesn't really mesh with what we're trying to do. I added QGMIX instead.

The ten year result isn't earth shattering but there was some real crisis alpha in 2022 which is shown in the worst year column. Bonds did well from the start of the back test up until late 2021 and 60/10/10/10/10 was underweight bonds the whole time. Additionally, foreign equities have lagged domestic for many years and 60/10/10/10/10 obviously had much less exposure to domestic than VBAIX. 

What 60/10/10/10/10 did was avoid obvious interest rate risk. Back in July 2014, when our backtest started, the ten year US Treasury yield was hovering between 2.40% and 2.60%. Getting a two handle for ten years made no sense to me back then and in hindsight still makes no sense. Of course yields kept going down but the risk that a year like 2022 would come along at some point never went away. 60/10/10/10/10 captured the effect while avoiding an obvious and serious risk.  

Jay Jacobs US Head of Active and Thematic ETFs at iShares was on this week's ETF IQ and was asked about whether buffer funds are being used as fixed income replacements given how poorly bonds have done lately. He spun out of that saying he thinks their popularity is more about easing people into equity markets. Just don't with the buffer funds. Whatever you are trying to achieve with a buffer fund you can do cheaper, simpler and with fewer things to potentially go wrong.

Kind of related, I registered for a webinar for Thursday morning hosted by VettaFi titled Q3 Fixed Income Symposium. OK, let's see what they have to say. Today I saw a Tweet promoting the webinar that gave more of a hint.

This is such a bad idea. It has come up many times before and it is always a bad idea. A regular equity with a solid dividend can still go down a lot in a bear market or some other sort of event like the 2020 Pandemic Crash. If you want 100% equities, go for it but if you want something, whether bonds are that thing or not, to cushion equity market volatility, don't use plain vanilla (dividend) equities. 

I believe the first dividend ETF was the iShares Dividend Select ETF (DVY). From May 2007 to when it bottomed in March 2009, it fell 60%. It was of course heavy in financials and it started falling seven months before the S&P 500 peaked in October. I pick that one because it is at least a variation on equity income. In that little crash at the end of 2018 it fell 13% versus 17.5% for the S&P 500. It then fell 31% in the 2020 Pandemic Crash, just a hair better than the worst of the S&P 500. In 2022 it did great as did most dividend ETFs, it was up 1.91%.

In terms of being bond like for offsetting equity volatility, I'd say DVY is one for four. Do you think that is good enough? How about the Global X Covered Call ETF (XYLD)? It has plenty of income of course, no equity upside to speak of which doesn't have to be bad but it does capture a lot the downside. It's not as old as DVY, XYLD only goes back to 2013. In the 2018 crash it went down 14%, in the 2020 Pandemic Crash it went down 32% and in 2022 it went down 12%. The 2022 number was a little better than the Aggregate Bond Index but I think comes up short in the context of offsetting equity market volatility. 

If you own any fixed income, why do you own it and what do you hope it will look like?

I believe the blue line is much closer to what most investors want their fixed income allocation to look like. The blue line effect could be created by blending a few things together with different attributes to get that effect but how many advisors and do-it-yourselfers do you think actually do that?

Part of the reason I've been critical of bonds is they take on equity beta in some instances, maybe a lot of instances. Hedging your equity beta with equity beta isn't really hedging. Hedging your equity beta with something that has even more equity beta, like dividend stocks or whatever they are going to talk about on the webinar is a worse hedge than volatile, long term bonds. 

We talk all the time about hedging with uncorrelated, negative beta or no beta diversifiers. The blue line is essentially no beta. 

If it works out that I can sit in on the webinar tomorrow and I am wrong about this, I will write a follow up.

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.

Replication Roundup

We have a bunch of quick hits today. 

The following is a great example of what an uncorrelated return stream looks like.

The name doesn't matter but I think the return attributes do. It is not intended to look like equities, it is intended to differentiate so it probably won't keep up with equities or 60/40 unless there is run like the 2000's and of course even then there can be no guarantee. The green rectangles hopefully isolate the effect. It's not always negatively correlated but has been for much of the time which makes it a desirable diversifier in smaller doses. 

The other day, I mentioned that there is research showing replication can be better than the real thing with the context being hedge funds or managed futures. Bob Elliott from Unlimited Funds and manager of the HFND ETF shares some thoughts in a blog post. "it’s pretty clear that most investors would be better off accepting the model error of a low-cost, tax-efficient replication than investing in high cost, tax-inefficient single manager investments." summed it up pretty well from Bob. It's also a supporting argument for the democratization of sophisticated strategies into retail accessible mutual funds and ETFs.

The Harbor Commodity All-Weather Inflation Focus ETF (HGER) started trading in early 2022, it's name certainly checks a lot of boxes. There are a few things going on with this one. It owns commodities that are sensitive to inflation like energies, agricultural and gold. It also tries to make the most of futures roll yield so maybe a little bit of carry which has been a buzz word for the last few months but note HGER did start trading before the recent focus on carry generated by the Return Stacked guys. There is a tactical overlay to change the weightings in the fund which could be a variation on trend. Like I said, it checks quite a few boxes and although it is just two and half years, so far so good compared to Invesco DB Commodity ETF (DBC) and the Direxion Auspice Broad Commodity Strategy ETF (COM)

One aspect of attributes like carry and trend that we may not talk about enough here is that while going too heavy into alternatives may not be a great idea, incorporating a little more influence from them is worth exploring. HGER is a commodity proxy, no question. In its short history, the incorporation of carry and trend appears to be benefitting the fund. 

Speaking of the ReturnStacked guys, they had a webinar in support of the ReturnStacked US Stocks & Futures Yield ETF (RSSY) which is their newest fund. For every dollar invested you are buying $1 of the S&P 500 and $1 of the version of carry that tracks roll yield. If you've been following them all along, there was nothing new in the webinar. We've looked at carry a few times and tried to figure out if there is a mutual fund that tracks it. It appears there is not one that tracks directly but Microsoft co-pilot thinks the AQR Alternative Risk Premia Mutual Fund (QSPIX) is the closest thing so why not use it as a proxy? 

At one point in the webinar, one of the guys mentioned preferring the combination of trend and carry. He did not mean just those two and nothing else but I could see where someone half listening could have thought that. It turns out this is a good example of why a little bit goes a long way but that there can be too much of a good thing. 

A 50/50 mix of trend and QSPIX went down slowly for three years straight from 2018 through 2020. Even after four years it hadn't made any progress. That is a long time to sit without any growth unless you decide to sit entirely in cash. This backtest is even further skewed because in 2022, the 50/50 mix of trend and QSPIX was up 30%. You can see with Portfolio 2 that by adjusting the standard deviation to equal that of 60/40, we get a CAGR that is higher by 269 basis points and the Sharpe Ratio is much higher. 

Also note that the 3-4 year run where trend and QSPIX did poorly didn't prevent Portfolio 2 from being competitive. 

Natixis has model portfolios that they advertise that you can check out here. On the plus side, they use both mutual funds and ETFs, they use products from plenty of other providers and they are not built with the plainest of vanilla funds. They have what amounts to four different versions of the same portfolio; Income, Conservative, Moderate and Growth. All four combine equities, fixed income, alternatives and cash. The respective weightings to equities are 31%, 36.5%, 54% and 62.5%. Income currently has a 10% weighting to alternatives and the other three have 15% weightings. 

Let's deconstruct their Growth portfolio and try to compare to something much simpler...a replication if you will.

First the Natixis Growth but I subbed in VBILX in for an Oakmark bond fund with a very short track record.

IVV and ASFYX are both in my ownership universe.

My attempt to replicate this as simply as possible while taking out the interest rate risk and volatility that goes with the duration taken in the Natixis model.

And the third one is just plain vanilla 60/40.

Over the course of six years, the Replication held its own but did lag a little albeit with a much lower standard deviation and better portfolio stats. The six year numbers benefit from going down much less in 2022. It is of course much simpler than the Natixis Portfolio.

An obvious flaw in the replication we did is that it is just a snapshot based on what the Natixis portfolio looks like today, the portfolio suite goes back to 2016. It is actively managed and if they do a good job with changes to the portfolio, the replication we did wouldn't capture that. Anyone so interested could track it going forward though by closely following their page. 

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.

Bonds Are A Source Of Unreliable Volatility

Man Institute had an interesting research paper that fishes into the same waters we do here. The first line from their paper was "the reliability of bonds as a defensive diversifier was brought into question in 2022, particularly in light of the inflationary environment." Their use of the word reliability amuses me because that is the word we've been using, bonds have become a source of unreliable volatility is how I've worded it most frequently. I mentioned work from Man Institute back in April. The current paper looks at a strategy they call the Yieldy Put and how to blend it in with a 60/40 portfolio.

Yieldy Put is 50/50 trend (managed futures) and long/short quality stocks. The rationale is that "both (strategies) historically performed well in equity crises yet had positive carry in the good times. Hence the ‘yieldy put’ moniker in the title of this paper. Further, the two strategies are complementary to each other, with L/S quality often capturing the sudden ‘flight-to-quality’ effect that can potentially derail trend-following strategies." They compare the following allocations. 

The sweet spot is 50/50 into a 60/40 portfolio and the other half into Yieldy Put. I modeled it with three different funds for the long/short piece, AQR Long Short Equity Fund (QLEIX), client/personal holding AGFiQ US Market Neutral Anti-Beta Fund (BTAL) and Invenomic Institutional Fund (BIVIX) that we looked at in May. They each do very different things. QLEIX tries to smooth out the ride, BTAL has a pretty reliable negative correlation to equities and 60/40 and BIVIX swings for the fences with a very high standard deviation. 

The rest of these models allocate 30% to iShares All Country World Index ETF (ACWI) because that's closest to what Man used, 20% to iShares Aggregate Bond ETF (AGG), 25% to AQR Managed Futures (AQMIX) and the last 25% to the respective long short fund mentioned above.

In the same period, the Vanguard Balanced Index Fund (VBAIX) which is a proxy for 60/40 compounded at 8.56% with a standard deviation of 11.63%. The QLEIX version is not night and day different, it has a somewhat lower but still adequate CAGR. The BTAL version shows that 25% to that fund is probably way too much. And the BIVIX version is of course interesting but a fund that can go up a ton, it was up 61% in 2021 and up 49% in 2022, can also go down a ton. That's more a rule of thumb than a comment specifically directed at BIVIX.

I remodeled these swapping floating rate in for AGG. The differences were much less than I would have guessed.

However, the TFLO versions did considerably better in 2022 than the AGG version. 

As a reminder, in 2022 VBAIX was down 16.87%.

We've gone through essentially this same exercise 100 times. Today's post was just a different variation on the same theme. Yieldy Put, the way we constructed it, is pretty solid but I wouldn't want to be caught with 25% in BIVIX in case it ever does go down as much as it went up in some of those years. I would also want to diversify the risk of so much into two alternative strategies. As we always say, nothing can work 100% of the time and diversifying your diversifiers mitigates that risk and in my opinion is worth the basis points that might be given up for that peace of mind. 

The paper referenced a well known sports cliche. "Attack wins games, defense wins titles." I'd never thought of this in terms of how I try to manage portfolios but of course it fits whether we're talking about smoothing out the ride or the concept of 75/50 (75% of the upside with only 50% of the downside) or something else. 

Participating in markets can be whatever you want but I think of it as a long game. My nephew was asking me all sorts of market related questions over the weekend at a family function. He's very new at it so I tried to gage my answers accordingly. I said the S&P 500 is it 5500 right now. It will go to 11,000, no question. If it only takes four years, that would be great. If it takes 20 years, that would be pretty weak but it will happen. Maybe, it won't take that long but maybe it goes to 2750 on its way to 11000. 

As long as you understand your time horizon and have the right asset allocation, you're (my nephew) account will do exactly what you need it to do. Knowing all that, leads me to wanting to smooth out the ride, have a little defense on at all times and "win the title."

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.

60/40? I Can't Even

Vanguard senior investment strategist Todd Schlanger made the rounds in two places over the weekend, Barron's and Yahoo Finance trying to defend the 60/40 allocation. 

From Barron's, "Sticking with the 60/40 strategy still makes sense...Despite steep losses in 2022, when stocks and bonds both fell, a 60/40 portfolio has returned over 20% since then, which should portend continued strong future returns." And in Yahoo, "It's a very diversified strategy and we think it's poised to do very well in the future."

The reason I am bagging on this, well there are quite a few reasons but first is there is no sort of forward looking anything, actually no sort of assessment of current conditions either. In both articles he offered a tweak of 60/40 in terms of incorporating foreign exposure as follows.

It doesn't back test very far because of BNDW. I tried to find an older Total World bond fund and struck out so please leave a comment if you know one that is older. Here are the results.

That the foreign blend lagged, doesn't matter because foreign equities have lagged by a lot lately. Foreign exposure is valid of course, but any portfolio heavy in foreign had lagged domestic only for the last few years so that is fine. This issue here is that there's no differentiation. They correlate closely. Someone who wants 60/40 stocks bonds and wants to include foreign? Then it's a fine portfolio.

But as we've looked at countless times, bonds no longer offer the diversification benefits they once did. I'm not sure they ever did actually because all the data that we can look at is skewed by a 40 year run where bond yields went from 15% down to a low of 58 basis points on the ten year US Treasury. That cannot be repeated. Whether 2022's bear market was a reversion to some sort of mean or something else, that event broke the 60/40 portfolio as it's commonly applied because it changed the correlation relationship between stocks and bonds. 

Mark Rzepczynski touched on this in a very short blog post, he said;

A switch from a -.5 to +.5 will double the volatility of a 60/40 stock/bond mix based on historical data. Think about it. You will see your portfolio can move from single to double digit risk while keeping the allocation the same. There will still be a diversification benefit from bonds, but you will have to live with more risk. Back to basics, the correlations across assets matter. 

Diversification can be thought of as a management of correlations and understanding when correlations change, all the better if you can understand why they changed.

As opposed to bonds being thought of as the diversifier to equities, they are maybe better thought of a diversifier. What's one thing we always say? Diversify your diversifiers. Equities are the thing that go up the most, most of the time. Asset class diversification can help ease the volatility of equity exposure as well as make a portfolio more robust when equities get pasted or otherwise struggle. 

This really isn't that 60/40 is dead, more like 40 into bonds is a bad idea. 60% stocks, maybe 10% bonds, 10% managed futures, 10% in an absolute return strategy that looks like what people hope bonds look like and 10% into some sort of diversified macro strategy is better? That's just an example, I don't have anywhere near 10% in bonds with any sort of duration but in the context of not all diversifiers can work all of the time, 10% in bonds isn't the end of the world just because they are not working. Maybe they will work again? If yields go down to 3%, then bonds will do well but taking that on with 40% of a portfolio doesn't make a lick of sense to me. 

So let's try that, 60/10/10/10/10 using Todd's equity idea.

The return stream isn't that differentiated, except when you needed it to be. 

No one needs diversification, until they need it if you take my meaning. 60/10/10/10/10 looks a lot like 60/40 every year except 2022 when it was down 7.19% versus 16.87% for VBAIX. Some of the portfolio stats really stand out too in favor of 60/10/10/10/10 despite 10% in what I think is about the last place you want to invest these days, bonds with duration. Replacing AGG with floating rate would increase the CAGR by 54 basis points and lower the standard deviation by 46 basis points with a smaller decline in 2022.

Yes, I've been harping on this bond thing for ages, since long before 2022. Ten or 15 years ago it was more about yields not compensating for the potential volatility, then it became more about yields at all time lows only being able to go up even if I didn't know when or if that would happen and now it is about bonds being unreliable diversifiers. This is a theme that has played and evolved over the course of many years. 

Who knows if ten or 20 year paper could ever get to 8% again. Although I think that is unlikely, all of the volatility and risk that bondholders might have to put up with to get 4% now, might be worth it at 8% or maybe 7%. There is some level, we all need to decide for ourselves what level, where the volatility would be worth it but not at 4%, 5% and probably not 6%. We can reassess if we ever see 7%. 

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.