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. 

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