We've had quite a few conversations lately about the importance of uncorrelated return streams. The concept is not new to the blog but the phrasing is. Portfoliovisualizer's correlation tool is very handy to grab the numbers but I think there needs to be some measure of why return streams are uncorrelated. Doing this between many different return streams (alt strategies) may not be plausible but a few should be.
This leads us to yet another uncorrelated return stream, the CNIC ICE US Carbon Neutral Power Futures ETF (AMPD). The fund is a little over one year old and has just under $5 million in assets. In looking at the website for the fund, I didn't see anything to indicate that this provider has other funds which leaves me wondering how long this fund can hang on. If this company had a $1 billion fund, that could provide enough revenue to carry smaller funds for a while, but it is still an interesting idea in the context of researching uncorrelated return streams.
It is legitimately uncorrelated. AMPD did well in the context of being and alternative strategy in 2023 and has gone almost straight down this year. When I've ever looked at anything remotely similar to this, they always seemed to be procyclical which would be a knock against it being a diversifier in the manner we are looking for. It is possible that given more time it would prove out as being more correlated than it has previously been.
If the fund survives and continues to be uncorrelated, as I sit here today, I have no idea why it is uncorrelated to so many other strategies. Why did it go up last year and why is it down this year? Is it overly vulnerable to politics. Was the market it tracks pricing in that the Presidential race would go to the left in 2023 and now it is pricing in it going to the right? I don't know but that seems like a good question. We are not going to have a political debate in the comments.
This is useful though for isolating process. An idea with compelling numbers, so why not look a little closer? I don't know why it went up, I don't know why it is going down and I don't know why it is uncorrelated. If this interests you, why not try to learn more? I will probably leave it alone but this is a good example for ruling something out.
A friend sent an article from Seeking Alpha called The Case For Alternative Assets with a joke asking if I wrote it under an assumed name. That was a good one-liner and sure enough, it makes several identical points that I've been making here for eons. The common ground between our conversation and the SA post related to the ineffectiveness of bonds, understanding what to expect from negatively correlated assets and the bigger theme of patience.
As we've looked at before, managed futures went years without what could be described as "good" returns but as the SA article and I pointed out previously, the thing with a negative correlation to equities, managed futures, was struggling as stocks went higher. That seems like a reasonable outcome, you don't want you diversifier to be your best performer. It's a little different now that the cash held to collateralize the futures contracts is now earning 5%.
I've referred to the 2010's as a dark winter for managed futures. It was a long slow event that weighed on returns. A short term even that can be problematic for managed futures are whipsawed markets. There was a violent but quick reversal in the treasury market last year that punished managed futures.
These sorts of things can happen to any type of alt. This reality doesn't mean they aren't effective diversifiers. Nothing can always work which is why you diversify your diversifiers and look for uncorrelated return streams as we've been discussing recently. In yesterday's post, I backtested a portfolio that was 60% equities and 40% managed futures with the caveat that I would never put that much into managed futures. The academic back testing for managed futures works. The academic back testing for style premia as discussed in the SA article works. Same with other diversifiers but any of them can get hit hard out of the blue, maybe for a long term event or maybe for a short term event. Diversifying your diversifiers with uncorrelated return streams will likely be the difference between a strategy that unexpectedly blows up being merely a frustrating nuisance versus an outright calamity.
One final point from a comment on the SA article. Always read the comments. The reader backtested utilities as an alternative type of asset class and it "worked." Looking at the combination of returns and volatility it looks for all the world like a form of diversifier.
NEE is client holding Next Era Energy and XLU is the Utility Sector SPDR. NEE has become by far the largest holding in XLU. XLU and any other sector fund that has been around for a while has benefitted from a performance by NEE that cannot reasonably be repeated. The tests that the commenter ran were skewed by NEE's monstrous returns.
When I talk about trying to understand why something happens or a strategy setting expectations or understanding cross asset dynamics, this is a good example of why. This one is an easy one to understand why utilities would backtest so well but not all of them are this easy.
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.
1 comment:
Thank you for your posts on diversification and associated ideas. Greatly appreciated.
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