Find The Flaw In The Portfolio Part 1

Let's try something different and see if it can go anywhere. If there's any engagement, maybe can do one of these every week or so. I will lay out a portfolio concept that is hopefully robust when compared to more standard benchmarks. The idea is for readers to weigh in with thoughts or anything they'd do differently.

Here's our first attempt.

BTAL and BLNDX are client and personal holdings and I own a few shares of MAXI.

MAXI does a lot of the heavy lifting for the growth rate. If MAXI had been flat, the portfolio would have lagged by about 5%. JEPY is one of these monstrous yield funds whose payout needs to be reinvested. OVL owns the S&P 500 with an overlay of selling index put spreads which is a bullish strategy. The effect of that is that it looks a lot like the S&P 500 but yields closer to 4%. There is some risk to selling put spreads but the spreads are narrow which helped with muting the adverse impact in the 2020 Pandemic Crash where OVL fell a little over 100 basis points more than plain vanilla S&P 500 and in 2022. OVL was down 22.20% versus 18.19% for the Vanguard S&P 500 ETF (VOO). To be clear, the put selling is not a defensive strategy. 

The equity exposure works out to about 42.5%. TFLO is a floating rate strategy and ARBIX is a fixed income proxy so that adds up to 30% in fixed income. Aside from being Bitcoin, MAXI provides exposure to asymmetry and volatility. BTAL is a reliably negatively correlated return stream. And of course BLNDX in addition to some of the equity allocation also adds managed futures to the portfolio. 

The first flaw I see is a pretty big allocation to short volatility. JEPY, MAXI and OVL all sell volatility in the options market. The combos that MAXI and OVL sell should help the fund avoid outright calamity but the spreads could be a drag on the entire portfolio in certain circumstances. JEPY just sells puts. The impact of a prolonged decline would hurt the fund but it would not be as bad as what I believe the impact on the WisdomTree Putwrite Fund (PUTW) if we used that instead. PUTW has a higher standard deviation than JEPY and I believe would be more sensitive to a decline than JEPY.

If we alter the backtest to put PUTW in for JEPY and remove MAXI and add that 5% to OVL we can back backtest to 2020. If you're following that, those changes have the Find The Flaw Portfolio 1 down 2.79% in 2022 versus a decline of 16.87% for VBAIX. The CAGR for the PUTW/no MAXI version was 198 basis points higher and the standard deviation was 7.50% versus 13.31% for VBAIX.

ARBIX's worst year was 2022 when it dropped 0.54%. It's been up every other year. It is a differentiated return stream to be sure and while it trades like a horizontal line that tilts upwards, it would be vulnerable to some sort of unpredictable event that "breaks" the convertible market.  

The equity exposure is very overweight the S&P 500 and by extension mega cap tech. As I write this on August 1, it's not a good day to be heavily exposed to big tech. I realize there is a balancing act to this and how well big tech has done for an extended period but if the music ever stops, I would expect the above portfolio to get pretty hard. Not as hard by any means as plain vanilla 60/40 as the 2022 numbers could be hinting at. I would still expect BTAL and the managed futures to soften the blow. 

I'm not trying to predict anything with that last thought, more like if it happens what should we expect? 

OK, what am I missing? Find the flaw, let's have some fun.

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.