Insane Portfolio Construction

Jason Zweig did a quick and entertaining hit titled What's Left to be ETF'd meaning what can be made into an ETF that hasn't already? It devoted a lot of space to a new fund that will hold names kicked out of broad indexes that has symbol NIXT. He also mentioned a filing for a new endowment style coming soon although I think Meb Faber from Cambria has a similar filing.

There was an odd suggestion to see single state, specific maturity (like the Bulletshares) muni bond ETFs. I say odd because I am pretty sure it would be very difficult to populate an ETF with enough muni paper from one state all dated 2029. 

I think there are other things to package into an ETF, plenty if we sat down and thought about it. I am all for anyone willing to try to list something going for it. Maybe they find a market or maybe not. There are funds that are crazy risky and crazy volatile and there will certainly be investors who either misuse them and get burned or they understand the risks, make a huge bet anyway and turn out to be wrong. That's going to happen. If you don't want that to be you, don't go all in with very high leveraged, single stock ETFs, don't put every nickel into a Bitcoin ETF and don't spend the entire dividend from a fund that yields 60%.

One ETF I've hoped someone would list is a fund comprised of global, publicly traded stock exchanges. I've owned one exchange for clients for most of my time in the business. When I first started there really weren't any domestic exchanges listed now there are several. The exchanges are like financial infrastructure and they tend to do very well.

There are two ETFs that are almost close, the iShares US Broker Dealers & Securities Exchanges ETF and the SPDR S&P Capital Markets ETF (KCE). Vettafi lists the top 15 holdings in IAI as adding up to 84.5% of the fund and the exchange stocks in the top 15 add up to 17.43% or 20.13% if you want to count Coinbase (COIN). KCE is equalweighted so looking through all the holdings, I count 7.62% allocated to exchanges or 8.64% if you include COIN.

Comparing both of them to the broader SPDR Financial Sector ETF (XLF), both IAI and KCE do quite a bit better. If you look at shorter periods of time IAI and KCE seem to trade off being the outperformer. If you look at the charts of foreign stock exchange companies, you'll see many of them do quite well. 

Looking at the four big domestic exchanges, three of them outperform XLF long term.

Note that client holding CBOE has periods where it deviates from the group which is one of the reasons I own it. A repeat idea here but because the VIX complex trades on the CBOE, I believe the CBOE is something of a proxy for the VIX, an increase in volume of VIX products like during some sort of crisis or panic, is good for CBOE and so the stock tends to go up during crises or panics quite often.

So some extreme modeling to to close out this post. ICE is essentially the New York Stock Exchange and Euronext and they may have acquired a couple of smaller players along the way. Portfolio 2 "hedges" ICE with CBOE. Portfolio 3 dials down the ICE/CBOE blend to target the same return as the S&P 500 but we don't even have to get it that low before the standard deviation drops well below the S&P 500 with a much better Sharpe Ratio. Portfolio 3 got a similar return to the S&P 500 with 25% in T-bills so it is a form of capital efficiency without using leverage. Obviously there are several hideous risks in Portfolio 3 but I think there is value in understanding how to blend volatility profiles to get a smoother result and the 25% to T-bills while it is a form of capital efficiency it is also a nod to barbelling risk into a narrower, even if just slightly, portion of the portfolio.

Finally dialing down ICE/CBOE/T-bills to equal the return of the Vanguard Balanced Index Fund (VBAIX) which is a proxy for a 60/40 portfolio.

Similar to the above, the results are much better and look at the worst year numbers, wow. 

It takes a little time to find and figure this stuff out. The mental barrier to entry is pretty low, you just need to spend the time....if you even believe in this at all which obviously I do but only in terms of influencing the portfolio's construction, I'm not running to put 65% of anyone's account into one stock.

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.

Pushing Back On A Big Fish

Dan Solin wrote an article for Advisor Perspectives titled It's Increasingly Difficult To Defend Your Complex Portfolio. Dan is a big fish but there are still things in the article that we can dig into and push back on. With regard to complexity, generally I hope that long time and frequent blog readers will recall my preference for a lot of simplicity hedged with a little bit of complexity. There is an element of relativity though. Simple to Cliff Asness is not going to be the same simple to most of the rest of us. 

Dan goes into detail about how two and three fund portfolios can get the job done and often outperform more complex portfolios over the longer term. The context with these is very broad equity and fixed income exposure. I say this in just about every post on this subject, those types of simple portfolios, just two or three funds, can absolutely get the job done. There will be times during the course of a full stock market cycle where simple, two or three fund portfolios will be painfully suboptimal. 

Any portfolio you could possibly derive will have drawbacks and the major drawback to one of these two or three fund portfolios is they will feel every basis point down during large declines. That should not be any kind of secret, it just how it is and depending on the nature of a given, large decline it could be very painful (repeated for emphasis).

Then Solin does something that might be kind of odd. He says

A simple, two-ETF portfolio – combining a total stock market fund like the Vanguard Total World Stock ETF (VT) with a short-term bond fund like the iShares 1-3 Year Treasury Bond ETF (SHY) or the Dimensional’s Ultrashort Fixed Income ETF (DUSB) – could be more than adequate for most investors.

If you are reading this blog, it's a good bet you do a lot of stock market reading. How many articles advocated  just T-bill exposure all those years as rates were going down? How many pundits, besides me, were talking about keeping duration very short and finding yield in other places? Maybe Dan was, just the T-bill part apparently, but there were very few doing so. Yes, calling myself out like that is probably not so cool but I've been doing that for ages and was clearly very early in terms of when duration became a problem. And if he has always advocated for nothing but T-bills for fixed income exposure, he had clients getting essentially no yield out of what was probably a large portion of the portfolio, figure most fixed income allocations range from 30-50%. When T-bills had little to no yield there were plenty of fixed income sectors that had yields in the threes maybe up into the low fours without taking on duration risk. 

If you know, whether he was calling for putting all the fixed income exposure into T-bills before 2022, please leave a comment but this doesn't sit right. It's either hindsight bias or he subjected clients to no opportunity for any return for their fixed income allocation for a long time. Some T-bills with no yield? Sure. Nothing but T-bills with no yield? Yeah, I don't know about that. 

He then pivoted to pick on alternatives. A lot of them are expensive yes. Many of them do not offer as much diversification as they are touted to do. As we try to sift through here frequently, many of them don't really "work" the way they are supposed to. 

Citing John Rekenthaler from Morningstar, Solin said "He (Rekenthaler) found that the returns of all alternative categories positively correlated with the bond fund, with seven of the 10 categories posting a high correlation."

I posted a similar table recently. I feel like with a little selectivity, the correlation can come way down. Maybe more important than the correlation stats is that worst performer in 2022 listed above was down 3.37% versus 13.03% for the iShares Aggregate Bond ETF (AGG) which tracks a much more likely bond benchmark for advisors than putting the entire fixed income allocation into T-bills yielding zero. 

Being skeptical about alts is important, while I enjoy studying them, I've said countless times that I study far more than ever make it into the portfolio. 

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 You Sure Your Diversifiers Actually Provide Diversification?

This will be fun. Meb Faber asked via Twitter for input on well known buy and hold strategies for some research or maybe to update previous work. He gave examples like Risk Parity, Permanent Portfolio, Talmud (never heard of that one), the Endowment Portfolio and there were comments for others including the Ivy Portfolio which is different from the Endowment Portfolio. There were more and Meb included 60/40 in his list too.

It's worth looking at the various portfolios listed, some might be new to you or to revisit ones you've looked at before and maybe do a little deconstruction. One thing you'll see overlap across quite a few of these are large allocations to REITs, like 20%. Twenty years ago +/- it was very popular to suggest 20% weightings to things like REITs and MLPs. On the first version of my blog I wrote regularly back than about what a bad idea that was in terms of thinking you were getting any sort of bear market or drawdown protection. 

The yellow highlights are big market events where REITs as measured by VNQ went down pretty much in lockstep with the S&P 500. The green highlights are some instances where REITs just turned down for whatever reason, maybe a little uptick in interest rates but either way. The overall lag in VNQ is a little misleading because Yahoo charts price only and VNQ has historically yielded quite a bit more than the S&P 500. The lag is big, just not that big. 

I'm not saying don't own any REITs but circling back to the title of yesterday's post, there's no reason to believe that large allocations to REITs now can help build robust and resilient portfolios. Maybe they used to, maybe something changed but I can't see how 20% could offer any zig when stocks zag. Portfoliovisualizer has the correlation between VNQ and the S&P 500 at 0.74 which is much higher than the S&P 500's correlation to utilities which comes in at 0.43. I wouldn't put 20% in utilities either. 

If the argument is that actual real estate offers true diversification benefits, sure. I don't know but I can't refute it and chances are the value of your home was not effected by any of the flash crashes, the mini crash at the end of 2018 or any other stock market events that proved out to be insignificant including The Great Dip Of August, 2024.

A lot of images coming, starting with modeling out the Ivy Portfolio, Talmud Portfolio, and a typical portfolio like we often create for blog posts. 

Ivy prepopulated by Portfoliovisualizer

Talmud

Typical Blog Portfolio

Plain vanilla 60/40 works most of the time even if it is far from optimal (my opinion) so the objective is not to look nothing like 60/40 but to have some resilience or protection when 60/40 gets hit. First, the long term result.

The low and negative correlation that some of the alts in the Typical allow for a slightly higher allocation to equities yet still that portfolio has the lowest standard deviation. I used ACWI instead of domestic equities to be a little truer to Ivy. The performance using the S&P 500 would have compounded about 260 basis points more with only a slight increase in standard deviation.

You can see by looking that Typical held up much better in 2022 because it has holdings that are fairly reliable in differentiating from stocks and bonds, something that I'm saying REITs don't do. In the mini crash in late 2018 the Typical did not stand out but BTAL went up and SHRIX, QSPIX and TFLO all went pretty much sideways. In the 2020 Pandemic Crash it didn't really stand out but again BTAL went up and SHRIX and TFLO went sideways. QSPIX felt that one a little more, it went down about 11% as the S&P 500 was falling 30%. I would note that QSPIX kept trending lower after the market bottomed in that event and I would also note that VNQ was down 38% in the 2020 Pandemic Crash. Despite the lousy year for QSPIX in 2020, the Typical was the second best performer of the four that year. In 2018, EBSIX went up until it's ex-dividend date and in 2020 it went up a little more. 

The year by year of all four isn't noteworthy other than 2022. Again, 60/40 "works" most of the time. The idea here is to build in some robustness when things go sideways as they do every so often. 2018 and 2020 were both fast events. The alts generally did what they're "supposed to do" but nothing can always be great. 

The point really is about having a basis to believe something you own to diversify equity volatility can actually do it when you need it most. I don't see how REITs can do that and if bonds used to do that, ok but I don't think they do anymore. That ended when the 10 year Treasury hit 58 basis points. 

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.

Robust & Resilient Portfolios

Bespoke Investment Group Tweeted out the following.

In the same period, the S&P 500 is up just under 11% so 15% looks pretty good. 

One big reason I avoid this part of the bond market is that it has equity like beta and I think the 15% gain supports that belief. The other reason is the vacillating correlation to equities. For the last couple of years I've been referring to all of this as unreliable volatility. 

If you want to trade duration products for capital gains, hell yeah, go and get some but that is equity beta. If you're trying to smooth out the ride versus being all in equities, duration is not the answer. 

Here's an interesting excerpt from Mark Rzepczynski.

Yet, if we are headed to a market slowdown or downturn, it may be worth looking at a subset of managers that may have timing skill at avoiding the downturn. Unfortunately, the sample size is very small for those managers. We just have not had that many bear markets. A middle ground approach is to add a strategy that does well in down markets. You are not directly investing in skill but playing the odds that the market will have characteristics that can be exploited by strategy action. For example, trend-following that is diversified across asset classes, investing both long and short, and follows trends that may be more likely to occur when there is uncertainty will likely do better in a period of downside transition.

This is what we talk about here constantly. If you read this blog regularly, you are already putting the time to understand the various strategies we talk about that do what Mark describes and so can draw your own conclusion on whether you believe in a given strategy, the appropriateness for your portfolio and whether you think it lives up to its billing. Not all of them do but one or two holdings that usually go up when stocks go down and a couple more that usually trade sideways with an upward tilt no matter what the broad market is doing can contribute to making a robust and resilient portfolio which is what all these posts are about, robust and resilient portfolios.

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.

The Trendiest Trend That Ever Trended

As we've looked at before, there is plenty of research to support going heavy into various forms of trend following. Meb Faber has talked about this quite a few times, the ReturnStacked ETFs exist because of this idea and here's another article that also talks about it by Optimal Momentum. The following was interesting, obviously citing Ray Dalio;

This is obviously a drum we've been banging for years for the most part. I disagree with them that holding equities for the long term is a bad idea but have gone through more adverse market events than I can remember at this point using strategies/exposures besides fixed income to help avoid the full brunt of large declines.

This led me down a little bit of a rabbit hole to look at using managed futures as a replacement for bonds. Here's a sampling of funds that do just that, they combine equities and managed futures in pursuit of a smoother result, there are probably other ones too. BLNDX is a client and personal holding.

Then I did a little DIY to blend momentum (trend) equities with managed futures (trend).  

Portfolio 2 uses BTAL as a hedge. BTAL is sort of anti-trend because it shorts high beta. The three versions in this backtest look like VBAIX almost all the time which is ok, VBAIX works almost all the time. They deviated in 2022 for the better and also in 2016 when they all lagged VBAIX.

To the excerpt above, the combination of trend and trend reduced risk and improved portfolio stats. Of course, there is no guarantee it will always work but then bonds didn't work in 2022. In the real world, 50% in managed futures is far more than I would consider but the study makes the point of how trend can play a crucial role in long term portfolio success. 

Matt Markiewicz from Tradr ETFs sat for a short podcast with ETF.com. This the is company that issued the 2x SPY ETFs with different reset periods. So far there is a weekly fund and a monthly fund and the talk during the podcast gave me the impression that the quarterly version is going to happen on October 1st. Again today, they were not too far off the mark. You can decide for yourself whether they are close enough to consider using but so far, no catastrophes. 

If you have any interest in learning about these, the podcast is worth listening to. 

Finally, a screen shot from a marketing email for a very low volatility mutual fund.

I circled the volatility. Obviously, this will be laid out to cast a favorable light on the fund but by and large it does well as a fixed income substitute. There are of course times where it lags all of those benchmarks listed. It has compounded at three times the rate of the iShares Aggregate Bond ETF (AGG) with half the volatility. On paper, who wouldn't want that but holding on to that type of strategy can be very difficult for trying patience. It goes for long stretches doing nothing or at least very little. It's a great example of the need for patience.

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.

Leverage Is Easy To Misuse

An update on the Tradr 2X Long SPY Weekly ETF (SPYB). The fund is 2x leveraged but unlike most leveraged funds, it does not reset daily, it resets weekly. SPYM from the same shop resets monthly. SPYB went through it's first weekly reset and while SPY was up 112 basis points on Monday, SPYB was up 218 basis points. So it didn't nail it to the basis points for perfect tracking but that is very close as a first impression. 

I mentioned the other day the possibility that the reset for these funds could be bigger than the daily funds. I'm not sure if that is simply wrong or hasn't come into play because of how the market did last week, almost straight down. Either way, it's a good first showing but it is still too early to draw any sort of conclusion. 

If you play around with the ProShares Ultra S&P 500 (SSO) which is a long standing 2x long fund with a daily reset, you'll see it is pretty close far more often than not. The potential for the new Tradr funds, especially the quarterly if it lists is a much simpler way to create a capitally efficient portfolio than with the multi-asset ReturnStacked suite. 

You wouldn't need to put your entire equity allocation into SPYB, meaning building a 60% weighting with a full 30% to SPYB, but maybe 50% into a plain vanilla ETF and 5% into one of the Tradr funds which gets you to 60% net long exposure leaving 5% left over for a little defense like client/personal holding BTAL which as we've looked at dozens of times has improved long term returns and lowered volatility. If somehow the Tradr fund malfunctions, you'd only be in for 5%

I think all of that lives up to the idea of a lot of simplicity hedged with a little complexity. 

Backtesting with SSO, the daily resetting fund, it does exactly what I'm talking about. Both versions with the leverage and BTAL look pretty similar long term with a small, but beneficial, impact on CAGR and a bigger impact on standard deviation. 

There may never be a consequence for these newer funds that use leverage or to the investors who misuse the leverage available via these funds, I have no idea and that is the point, it is not knowable. This is similar to what we talked about here and other places for many years about all time low interest rates that kept going lower. The risk was there all the way down and there may have never been a consequence, it turns out there was in 2022, but the risk was there. Same with misusing leverage. That has been a contributing factor to countless crises over the years and will be again at some point. 

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.

AQR Uses Leverage, Should You?

What a great day. I got a good bit of outside work done this morning and it's the first day of NFL Redzone so why not dive into some portfolio theory on the blog?

Following up on yesterday's look at the Dragon and Sloth portfolios, I had a thought about what to do with Dragon's 21% weighting to long volatility and how trying to use a long VIX product creates a huge drag on the result, so huge that replicating the portfolio really isn't valid. 

We've noted more than a few times that client holding CBOE Global Market (CBOE), the exchange where VIX trades, has some of the defensive attributes that go with being long volatility. I believe the reason for that is a market crisis potentially causing more trading in VIX derivatives is good for CBOE which causes the stock to go up in quite a few different types of broad market drawdowns. I'd describe this as fairly reliable but certainly not infallible. FWIW, CBOE has a kind of low correlation to the S&P 500 at 0.34 and was only down 2% in 2022. 

Here's how we replicated Dragon;

Portfolio 2 as indicated just swaps out VIXM for CBOE and Portfolio 3 is "My Version" from yesterday but 10% to CBOE instead of VIXM.

Portfolio 3 with the highest weighting to equites (we're considering CBOE to be long volatility) doesn't have the highest CAGR but it was better than VBAIX, with a much lower standard deviation and the best Sharpe Ratio. The truer replication of Portfolio 2 was the best performer but that obviously is because CBOE outperformed the S&P 500 meaningfully over the period studied. CBOE might continue to outperform, I don't know but I think the defensive attribute we described above can persist as long as it continues to be home to the VIX complex.

Cliff Asness had a long writeup In Praise of High Volatility Alternatives. The meat of the post compares different weightings to stocks/bonds/alternatives building more and more leverage into the portfolio. Cliff focused on this exercise with a volatility target of 10%. I'm using his weightings for this exercise but the volatility targets don't quite get to 10%. That's ok, I think pull some interesting information. 

Portfolio 2 with 17% leverage has lowest CAGR. The trade off between no leverage and 51% leverage is interesting. 58 more basis points in CAGR with leverage but inferior standard deviation and Sharpe Ratio. 

The next version uses AQR Style Premia Alternative Fund (QSPIX) for the alternative. 

You might draw a different conclusion but the unleveraged version seems to be the most compelling combo. The argument is pretty strong at least. 

With AQR Diversified Arbitrage (ADAIX).

Again, unleveraged seems to be the best of the bunch but unlike the first two, the standard deviation of all of them exceeds the CAGR.

The last one we'll look at is the Catalyst Millburn Hedge Strategy (MBXIX) which a hedge fund-like mutual fund with sort of a high equity beta compared to most of these types of alts. With this one, the argument for unleveraged isn't as strong with the others. The CAGR is 108 bp lower than the version with 51% leverage but the standard deviation is 231 basis points lower. 

My tendency is to be very cautious about using leverage. I've talked countless times about leveraging down as opposed to what we're doing in this study of leveraging up. Anyone wanting to follow Cliff's lead with the leverage could use either ReturnStacked Global Stocks & US Bonds (RSSB) which gives $1 of exposure each of the two assets classes in the name of the fund for each $1 invested or the WisdomTree US Efficient Core ETF (NTSX) which leverages up such that a 67% weighting to NTSX equals 100% into a 60/40 portfolio. To buy either one though, you have to want Agg-like bond exposure. 

It would take some creativity and a high tolerance for tracking error to get to the 51% leverage in Portfolio 3, the 17% in Portfolio 2 would be pretty easy to get to or of course anyone interested in actually doing this would probably go with whatever number they found to be optimal. 

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.

Defense Without Bonds

In 2022 we wrote a couple of posts about the Dragon Portfolio which an interesting idea inspired by the Permanent Portfolio which allocates 25% each to stocks, long bonds, cash and gold. Dragon is similar to the Cockroach Portfolio in that it is offered at a high minimum to sophisticated investors. Maybe. As I look at the Dragon website, pages are not populating correctly and I found some hits on Google that talked about outflows due to poor performance. I don't know what is going on but when we looked at it two years ago, our attempts to replicate it resulted in a CAGR below two. It can still be interesting to study and after two years could the allocation have started to pay off?

• Equities 24%
• Long Volatility 21%
• Gold 19%
• Bonds 18%
• Commodity Trend 18%

This is how I tried to replicate it in 2022

Keep in mind that, like Cockroach, anything we might do with ETFs and mutual fund won't really capture what the actual fund can access to include in its portfolio. It's more like, the asset allocation idea is interesting, is there a way to get close? Whatever Dragon does/did, it's a good bet it is using a manager(s) that gets a result for long volatility that is much better than the manner in which VIXM bleeds. A small allocation to VIXM can be effective but 21% is a huge weight to something that goes down very frequently.

The last couple of years though improved the results slightly, the CAGR got above 2%.

Dragon was a decent place to hide in 2022 dropping about half as much is VBAIX but in 2023 it had literally no upcapture. While I am certain that the volatility sleeve was better than our backtest with VIXM, if the fund had trouble with poor returns, that huge of a weighting to long volatility is the first place I would look. 

I like the phrase too clever by half, I've used it here several times and some of these portfolios we look at seem like they could be too clever by half to actually implement but I would double down on the idea that studying them is beneficial. I used TLT which seems like a reasonable proxy for long bonds but that fund is down 50% from its all time high. Removing that money loser in favor of one of the floating rate funds we use for blogging would help the result as would greatly reducing the allocation to VIXM and putting that into equities.

Now Portfolio 2 has more equities, less VIXM and owns TFLO instead of TLT. The CAGR came up quite a bit, it still doesn't look too much like 60/40 for growth but the standard deviation is very low, lower than our attempt to replicate the Dragon Portfolio and the portfolio stats look better. When tinkering with these things, don't be afraid to have a normal-ish allocation to equities. 25% in stocks means having to get a lot of growth out of other asset classes that probably not as growthy. 

All of that is a preamble to today's post. Blogger Nomadic Samuel is do-it-yourself investor who writes a lot of very fun posts about some thought portfolio ideas that are very highly leveraged. While I think all the leverage is a Black Swan waiting to happen, it's still fun. He has a portfolio he calls The Sloth which he says is Dragon Inspired. 

He is big on the ReturnStacked Fund suite but they are all so new that backtesting with them doesn't tell us much but we can replicate them on Portfoliovisualizer and still capture the leverage. First up is the allocation of The Sloth.

BTAL is a client and personal holding. TAIL is the newest fund but goes back to 2017 so we get a decent backtest. Portfolio 2 is the same allocation but reduced proportionally to cut out the leverage so ACWI has an 18.75% weight, TAIL is 9.375% and so on. For Portfolio 3 (Roger's Version), I built the following.

It's a tweak on The Sloth but no bonds, less to TAIL and BTAL with more to equities. It's still not a normal allocation to equities but that's ok. 

None of them keep up with VBAIX' growth rate but the Sloth and my version are kind of close. The standard deviation to my version is about half that of VBAIX. The 2022 results are interesting.

You can decide for yourself whether there is any validity to any of this. The idea from me was to create a similar result without the added layer of risk from so much leverage as well as avoiding bond duration. The result from my version is not so far off that I'd conclude NFW like I would from the Dragon Portfolio, there's NFW with that one. My version is yet another example where the defense that people hope to get from bonds can be had without taking on what has become unreliable, equity-like volatility that now exists in the bond market. And repeating for emphasis, twenty something percent in something like tail risk or long VIX should be expected to create a huge drag on a portfolio. 

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.

The 5% Rule?

Barron's dusted off the retirement bucket playbook in an article while also arguing that a 5% withdrawal rate in retirement can now be considered safe versus the more common 4%. Before I forget, read the comments on this one. Always read the comments. 

First to the buckets. They suggest two years worth of cash invested in cash proxies (my word, not theirs), 5-8 years in income producing securities like bonds and then put the rest in growth like the stock market. Then do the work to maintain the appropriate balance in each. Later in the article, Christine Benz from Morningstar argued for yet another bucket, if you can, that would be untouched to replace buying long term care insurance for possible end of life care. 

For anyone to whom this appeals, they could obviously have different time frames in mind with the buckets. With the cash bucket, maybe one person would think 18 months is sufficient while someone else might want a longer period. I might argue longer than two years considering the bear market from 2000 took 30 months to find a bottom. Also the 2000's being a bumpy ride to nowhere for the S&P 500 might lead people to view this part more conservatively too. 

If someone likes this idea and can avoid repeating behavioral mistakes then it probably works out just fine, I can't knock it on that basis. It does feel like it adds a layer or three of complexity versus just maintaining a diversified portfolio (whatever that means to the end user) and some cash set aside to help avoid being done in by an adverse sequence of returns. 

I think the concept underlying that middle bucket of 5-8 years in fixed income can be replaced with a smaller allocation to holdings that will very likely be up when stocks are down or at the very least are likely to not go down with stocks. Starting with a hyperbolic example. If a portfolio has 50% in the S&P 500 and 50% in an inverse S&P 500 fund and then the market falls a lot, that inverse fund will likely be up a lot and selling some for income needs avoids selling anything low and at least partially rebalances back to 50/50. 

The example is absurd for quite a few reasons but now dial back the exposure in something that has attributes similar to an inverse fund to a small percentage and then maybe have some exposure to things that seem to always go up just a little bit (lagging bull markets, outperforming bear markets). These holdings can be a source of funds if some how the cash gets exhausted and stocks are still down. 

Pivoting to whether 5% is a sustainable withdrawal rate instead of 4%, yes it probably is. The way the math works out, 4% has a success rate in the low 90's based on simulations and has never failed looking backward. "Success rate" is defined as lasting for 30 years with a 50/50 split between equities and fixed income. At 5% the success rate drops to what I recall as being 88%. 

The difference is not dramatic. More important than the 100 basis points is building in some resiliency with something like adding a third income stream, the first two being Social Security and retirement savings, to bolster resiliency in case something crazy happens with one of the other two. By crazy, I mean like Social Security actually getting reduced or a longer than normal bear market for equities. 

Real estate is a simple first place to look but there is risk, it is capital intensive as far as a down payment, making upgrades every so often and fixing things. We've had mostly good luck personally with real estate beyond our house but while looking into this sort of investing is very worthwhile if you can find the right situation, I would be cautious around pie in the sky view points (read the comments in the Barron's article).

Creating an income stream by monetizing a hobby is one we've been talking about for more than 15 years. Is there something you've invested a lot of your time in doing? If so, you'd be able to figure out whether there is a path to monetization, there may not be, but if there is, get started now. 

The importance here is that an additional income stream can relieve some of the burden from your investment portfolio. In the random year or two that stocks are down a lot, having the flexibility to take less or maybe nothing from your savings as you ride out some sort of stock market calamity would lower stress considerably. As a reminder, just because you might have to take an RMD, you don't have to spend your RMD.

My own biases here involve not wanting to have to worry about money, that's pretty high on my list. Living below my means and creating some sort of additional income stream seems like the simplest path the financial underpinning I hope to achieve. 

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 Get Minskyied

If you were involved in markets during the financial crisis, you probably came across the term Minsky Moment. Attributed to Economist Hyman Minsky, the simple version is that a lack of volatility results in complacency on the part of market participants which is when crises happen. It's a little more involved than that where cash flow exceeds the amount needed to service debt causing that excess to speculatively chase prices higher before it ends in crisis. There is a relationship to Black Swans, the end result of the Minsky Cycle as it is sometimes known could be a Black Swan like the Financial Crisis. 

The simpler variation of a lack of volatility leading to the bad kind of volatility is the purpose of this post. A couple of times recently, I've quoted Tarek Abou Zeid who made a joke about catastrophe bonds not having any risk or volatility until they do have risk and volatility. That joke overlaps with Minsky.

The portfolio labeled as Minsky, is comprised of three funds. It tracked 60/40 until 60/40 broke in 2022, it has had much lower volatility and far better portfolio stats than 60/40. Looking at the track record, who wouldn't want that smooth of a ride combined with a robust result in 2022 when it was up 2%? 

The Minsky portfolio allocates 70% to a fund that combines equities and managed futures, 20% to a catastrophe bond fund and 10% to fund that sells volatility that is pretty far out of the money. 

Cat bonds and selling volatility are two great examples of no volatility or risk until there is volatility and risk. The right (or wrong) combination of wind events and wildfires could cause real problems for cat bonds. Some sort of Volmageddon redux (in the last couple days people have noted unusual action in VVIX, the volatility of VIX as concerning) could hurt the volatility fund. It had some sensitivity to the big drop on August 5th and a little less so to Sept 3rd. We've noted a couple of times in the last couple of years where managed futures got whipsawed pretty hard, once in a sharp reversal in bonds about a year and a half ago and then last month with the yen.

Now imagine a slightly bigger event happens to each of the three of them at the same time. You might be down 25% in a down 5% world or maybe the world goes down 25% too but snaps right back like in the Pandemic Crash of 2020 but the Minsky Portfolio we created for this post does not. 

How likely is that to happen? Very unlikely, but that is not the point. We do a lot here to focus on managing volatility and the tools discussed today and other tools we talk about, for my money absolutely work but they are not riskless. Equities continue to work and we are frequently reminded of how unriskless they are. Eventually, something with no risk circles back around to become very risky ala Minsky, there is risk waiting in these tools. There may never be a consequence for that risk but it is crucial for good portfolio management to understand the risks of the core (probably equities) as well as the defensive components to avoid getting Minskyied. 

Closing out with a quick follow up on the Tradr 2x SPY ETFs we mentioned the other day. SPYB resets weekly and SPYM resets monthly. They don't really have any interest yet. You can see today they were down about four times what the reference SPY ETF was down but that was the market price. According to the Tradr website for SPYB the NAV dropped from $23.86 yesterday to close at $23.73 today. So the fund is trading at a discount but the percentage drop today in NAV of 0.54% is reasonably close. I did not get the info for SPYM. It is too early to know what to make of these but it is worth following. 

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.

The Tradeoffs Of Living A Balanced Life

Two articles with entirely different viewpoints on when and how to retire. The first one from the WSJ is about people taking intermediate length, six to 12 months I'd guess, sabbaticals every so often without prioritizing the potential consequences for retirement planning. A reader left the link to this article and then of course later on Wednesday, I saw it shared elsewhere a half dozen times. So, it's a hot topic.

Think about it, if you quit to take six months to do some huge life experience and then try to go back to the work force in the same capacity and commensurate pay then at the very least you're disrupting your retirement savings flow. 

The idea of not waiting until "retirement age" to....describe it however your want....own your own time, do a couple of adventurous things will appeal to most people. Optimizing quality of life and retirement planning are conflicting ideas that need to be reconciled in order to succeed.

Wanting to enjoy the ride or live in the present are valid aspirations. That is offset by the need to do favors for our future selves like having at least some savings, maintaining at least decent fitness and health as well as staying connected (vague reference that takes in many aspects of successful aging). Those two can be at odds so a balance needs to be struck. 

With anything we do in life there will be tradeoffs. To the WSJ article, if quit your job to take six months off to hike the Pacific Coast Trail and then try to reenter the job market, the tradeoffs might be getting a similar but lower paying job to start, not being able to get back into your previous field and having to start with a drastically lower paying job, the interruption in your retirement savings could have a future impact on what you have when you actually retire. 

If there are tradeoffs, that means something will not be optimized. If you don't really enjoy what you do and you don't venture out on some sort of sabbatical or adventure then you're not optimizing your potential for joy when you're young. If you check out of the work force regularly along the way then your not optimizing your retirement savings. Can you figure out a long term balance to hit all the things that matter to you?

I have several Facebook friends who still work at Charles Schwab from when I was there in the 90's. Being there that long appears to allow them one month sabbaticals kind of frequently. While the idea of punching a clock that way for all these years since I got laid off in 2001 (best thing to ever happen to me professionally) would be depressing as hell, it is important to understand we are all wired differently. I could see where the occasional one month sabbatical could be the answer for people. 

It's not for me to say what the right thing for other people to do is but I will say feeling like you struck the right balance for yourself does require self-awareness to understand personal priorities. Your priorities are not my priorities which are not the other guy's priorities. Hopefully everyone can figure this out for themselves, understand how they want to live, then understand the tradeoffs and be prepared for potential consequences. 

Let's say you're making a lot of money, you've socked a lot away for retirement and at 50 you see one of those commercials for Army Civilian Careers and you decide you want to change everything to be a heavy equipment operator in Alaska for 1/4 of the pay. We've talked about this sort of example many times. At some age you decide you want to do something completely different, do you have the financial flexibility to do it by virtue of smart financial and lifestyle decisions? This 50 year old we're talking could easily have enough accumulated to take a severe pay cut, still making enough to pay the bills but not save any more for retirement. That seems like a pretty good outcome. This is referred to as coast FIRE, being able to get by without needing to add to saving and without needing to pull from savings. This scenario is not optimizing savings but so what, maybe that wasn't their priority. 

This all contrasts with an article about financial advisors that ThinkAdvisor says are afraid to retire. The fear isolated in the article was not so much about lack of financial ability to retire but about identity. This will be harsh but we all know people whose only dimension is their career, it's all they have. 

Saying this as someone who loves what he does, being one-dimensional is not a good way to go through life. Aside from varied interests making life more consequential, problem solving and challenges in one area of interest can help with problem solving and challenges in another area of interest....the more important area of interest perhaps. My day job is my most important area of interest (family and health are not areas of interest, that's different) but I can't count the number of times where fire department stuff has helped with something in my day job. 

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.

Capital Efficiency Takes A Step Forward?

The market for leveraged ETFs took an interesting turn today with the launch of 2x leveraged funds by Tradr that target weekly and monthly outcomes instead of the typical daily outcome. According to the prospectus that covers all of them, quarterly versions will be out on October 1st. 

My first thought is, if they work, I say IF they work, they are a path to democratizing do-it-yourself capital efficiency in a portfolio. While I am skeptical of the ReturnStacked funds, we've written a lot of posts going back a long time about using leveraged funds for capital efficiency, that is to say leverage, before I'd heard the term capital efficiency. 

I've said many times, going back a while, I've made the observation that holding 2x long S&P 500 has not been catastrophic. It's been pretty close far more often than not on a year to year basis. If you spend the time, I'm sure it would be easy to tease out periods where the difference between 1x and 2x was not pretty close. The 3x has not been that terrible year to year either. The worst year for 3x was either 2015 when the S&P 500 was up a little and the 3x was down 5% or it was 2020 when the S&P was up 18% and 3x was only up 9%. 

The longer term compounding is less favorable due, in all likelihood, to the leveraged funds having to dig out of some big holes after large declines. If the plain S&P 500 drops 3% one day and 3x drops 9% like it should, that can be a big hole to dig out of. And the depending on the sequence, that could compound into a very painful drag versus not using leverage.

The best example of a leveraged ETF catastrophe is probably with Microstrategy (MSTR) and a 3x long version that trades in London.

The common is up 207% this year and, as I mentioned the other day the 3x long is down 84%. To make one thing clear, this post is not that I think leveraged ETFs are the answer, more like an exploration to see if the this next evolutionary step with leveraged funds, the monthly and soon to be quarterly, could be useful. It's way to soon to know but I am curious to see if they can work out.

Playing around with how 2x Long SPY Monthly ETF (SPYM), or the 2x Long SPY Quarterly ETF when it lists, I think we can use SSO and be close.

The way I laid it out, Portfolio 1 is plain vanilla 60/40, Portfolio 2 tries to create an apples to apples comparison and Portfolio 3 is in line with what we usually blog about in terms of avoiding interest rates, using a couple of alts as well as a small position in client/personal holding BTAL.

There were no catastrophes with SSO but it doesn't always track perfectly of course and going forward there is no way to know if there could be a catastrophe or not. As a theory, I think there is a fulcrum point of volatility where the leveraged funds track less closely maxing out at the Microstrategy catastrophe we mentioned above.

The Tradr ETFs target, weekly, monthly and soon to be quarterly outcomes. Giving them the benefit of the doubt that they will do what they say they will do, I'm not sure what holders should expect it to look like mid week or mid month. If one month from now, you know that the S&P 500 will be 1.75% higher, I'm not sure you could know what path SPYM will take to gaining 3.5%, again I'm assuming it will work. 

Also, I am not certain, but I think the odds are pretty good that the reset at the end of the week, month or quarter could be much larger than the daily funds. The monthly fund resets on the last trading day of the calendar month. It might make sense to sell before the reset and then buy back in the next day (or after the reset has occurred). Being out of the market might for a day or maybe two might not be great but you could swap into a daily resetting fund for the day or an unlevered fund to avoid being completely out.

This all implies a lot of work and you'd find plenty of different takes on whether it's worth it. The strategy could work but the utility is in the eye of the end user and of course, this really wouldn't make sense in a taxable account. I am going to watch though to see this idea could "work."

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.

Mimicking Allocation, Not Constituency

Following up on yesterday's post, I thought of a way articulate the way in which we deconstruct sophisticated portfolios like the Permanent Portfolio, the Cockroach Portfolio or in the case of yesterday's post, the Trinity Portfolio. Click through to yesterday's post if you want more context.

The idea is to study the allocation, not the constituents. Look through at the various Trinity links from yesterday, you'll see the ETF and the SMAs have a lot of holdings. The Cambria Trinity ETF (TRTY) shows 27 different ETF holdings plus two cash proxies. That seems like a lot of ETFs for a fund of funds. In the real world, the portfolio I manage for clients includes a lot of individual stocks and 27 is in the neighborhood of how many names I hold on the equity side of the ledger. 

That sort of portfolio constituency seems very complex to me. What do you think Trinity, or one you might be more interested in, is trying to do? I think Trinity is trying to smooth our the ride versus a typical 60/40 portfolio but still get some upside participation.

Ok, it smooths out the ride but I think there are way to get a similar volatility profile but with a little more upcapture, using Trinity's allocation weightings. 

Let's look at Trinity 3 since we did not look at that one yesterday. According to the Trinity performance data, from Nov 2016-March-2024, Trinity 3 compounded at 5.08% with a standard deviation of 8.61% and a max drawdown of 15.59%. Here are two much simpler versions of Trinity 3, one with AGG for the fixed income proxy and one with floating rate as the income proxy as follows. 

As we talked about yesterday, it looks like trend is comprised of some sort of actively managed split between managed futures and momentum equities. I used ACWI instead of and S&P 500 fund because I believe that makes for a fairer comparison to Trinity 3.

Portfolio 3 is simply the Vanguard Balanced Index Fund (VBAIX) which is a proxy for 60/40. Portfolios 1 and 2 have a lot less equity exposure than VBAIX and a chunk of that is in foreign which has lagged domestic. Neither version of Trinity we made is likely to keep up performance-wise but it is a lot closer for the same period as the more complicated, actual Trinity 3. Both the AGG version and the TFLO version actually end up with a lower standard deviation than Trinity 3. The Trinity performance page shows the max drawdown for Trinity 3 at 15.59% but I am not sure if that was in 2022 or not. The AGG version was down 2.90% in 2022 and the TFLO version was up 2.05% that year. FWIW, the Trinity ETF was down 3.32%. 

I think there is something to the Trinity allocation but not the constituency or what I perceive as complexity. The tradeoff though is that in some years, like 2023, the AGG version and the TFLO version could get left way behind, they were up about half as much is VBAIX last year. 

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.