The Tradeoffs Of Low Volatility

Bob Elliott who manages the Unlimited Hedge Fund ETF (HFND) had a blog post that took a dim view of the defined outcome funds, also known as buffer funds. Read the post but the following graphic stood out to me.

WRT to buffer funds, Bob did the work to show whatever you're trying to achieve with a buffer fund can be done in a better way. We've made that point here quite a few times. The graphic also starts to go down a road we've gone many times which is how to think about diversification differently, how to reduce the volatility of the overall portfolio, irrespective of what individual components are doing. Focusing on the trees (individual holdings) instead of the forest (the portfolio) is referred to as line item risk. Invoking Jason Buck, if you're diversified, you will always have a couple of holdings that make you want to puke. 

A few days ago, we took as quick look at how some diversifiers did during The Great Hiccup of August, 2024. Reading the post from HFND made me curious about how that fund did and maybe a couple of others. I mentioned this in some post that while it seemed like The Great Hiccup is destined to be forgotten, it is a good event to learn from.

HFND and HEQT should have smaller swings in both directions. They generally meet that expectation but of course that means over longer term trends where stocks go higher, they are unlikely to keep up. For the month they look good of course. They could be the anchor for a portfolio that doesn't need to keep up with the broad market longer term or as a tool around an anchor to help manage volatility. 

ISPY is a covered call fund that I've mentioned a couple of times. It is in my ownership universe for just a couple of clients but I think it is the best choice for combining decent yield with decent upcapture when looked at versus the other derivative income funds. Covered call funds should not be thought of as a place to hide or crisis alpha. It went down inline with the S&P 500 which is what I'd expect. 

I don't know what RSSY should look like during a fast decline but we talk about it enough that I just threw it in. While we're talking about ReturnStacked ETFs, they launched the Return Stacked Bonds & Futures Yield ETF (RSBY) today. Like it's other funds, it is a 100/100 fund, bonds and carry. I don't know what to expect from RSSY like I just said and I don't know what to expect from RSBY either. RSSY has $148 million in AUM per Yahoo Finance. I've seen other people talk about carry in a favorable light but I would suggest treading lightly for now. 

Moving on to repeat a point we've made before but is worth revisiting. Portfolio 1 is a blend of simple equity beta and alts that we talk about regularly here. For now, the details don't matter.

The volatility is about half of Vanguard Balanced Index Fund (VBAIX) which is a proxy for a 60/40 portfolio. The tradeoff for such a low standard deviation is a slightly lower CAGR. I highlighted various declines in the ten year period we're studying and you can see the ride is much smoother. 

That sort of long term result is probably appealing to plenty of people but look at the year by year.

There are several years in there where Portfolio 1 was up less than half of what VBAIX did. Those years are difficult to ride out. If we project out forward another ten years, I think it is reasonable to believe that Portfolio 1 would be kind of close to VBAIX with a smoother ride but with more years where it is only up half of what VBAIX does. There are countless valid ways to construct a portfolio. Maybe Portfolio 1 is valid, maybe it isn't but any portfolio that is valid will have periods where it lags. Knowing and accepting that ahead of time hopefully makes it easier to remain patient over the course of a cycle. A portfolio strategy is chosen for a reason(s), let it work for you over the course of the cycle. 

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.