Hell Bent On Leverage?

The Stone Ridge ETFs that seek to annuitize income streams via a longevity pool have hit the market. They seem to be complicated and I have yet to dig in but it appears they switched formats from using traditional mutual funds that can't be sold once holders reached 80 to this ETF format that switches to a closed end fund for the distribution phase. Hopefully I can dig in soon but the first iteration, the mutual fund plan, seemed simpler. This might still evolve more, whether with Stone Ridge or competitors but annuitized, not annuities, is something to follow closely. 

Steve Sears' column this week in Barron's is a must read. 

Wall Street wants you to be a short-term event addict. If you are overly focused on daily happenings, you will often be confused, make suboptimal decisions, and likely lose lots of money because you don’t understand how to focus upon, much less find, the path that leads to consistent returns.

He goes on to say 

If you want to be a more successful investor, don’t waste your limited energy and resources on quotidian matters that lead nowhere. Instead, use your time to identify and continually refine enduring guiding principles for your investments. This is important. Investing is a multidimensional strategy game played over decades against people all over the world.

You might see some overlap in what we talk about here, at least I hope you do. The name of this blog, Portfolio Lab, is about the constant refinement of the portfolio process which is very much a "multidimensional strategy game."

Fidelity Institutional started a series of short videos titled The Search For The Next Great Portfolio, episode one was called Is 60/40 Dead? No link from me, I'm sure if it is ok to share given the target audience but you mind find it via Google. The first one was only eight minutes and was very thin but there was one little nugget from Matthew Miskin from John Hancock about whether to pull from equities or fixed income to allocate to alternatives. 

He said it depends on the alternative. We've talked countless times about about merger arbitrage and convertible arbitrage (there are others) being substitutes for fixed income or as we've said here, proxies, that should be pulled from the fixed income allocation. He said that other alts, he specifically said global macro, but again there are others, are closer to being equity-like and should be pulled from the equity allocation. So maybe 60% equities becomes 55% equities and 5% global macro (using his example) and 40% fixed income becomes 35% fixed income and 5% merger arbitrage, again I am using his examples. 

The following graphic is from AQR. Portable Alpha is older jargon that means the same thing as capital efficiency or ReturnStacking, using leverage to add some attribute to the portfolio and in the case of this graphic the attribute is alternative strategies. Adding Portable Alpha is the opposite of the previous paragraph about where to find room to add alternatives, you just leverage on top. 

If Portable Alpha can be done effectively in a fund, then AQR is one who can do it. They essentially are doing some version of it in various funds they manage. Beyond that, I think it is pretty difficult to pull off inside of a fund.

The three portfolios are all similar and I used RDMIX to benchmark since they leverage up about the same as the AQR slide. RDMIX appears to be currently leveraged up 62%. Portfolio 1 has 60% leverage, Portfolio 2 has no leverage inline with how I talk about how to do this as well as inline with Miskin's comments above and Portfolio 3 leverages up just 10% which is a little closer to how I think, still only putting 5% into two different alts, global macro and merger arb like Miskin said.

Portfolio 1 with 60% leverage did outperform by quite a bit with the tradeoff being a higher standard deviation. All three portfolios and RDMIX offered varying degrees of protection in 2022 compared to VBAIX which was down 16.87% that year.

RDMIX did have the lowest drawdown in 2022 but its CAGR is less than half the other portfolios. It's not quite apples to apples as I don't think it has 60% equities very often but it does have 50% so I think it should be closer than it is to the other portfolios. The standard deviation isn't so hot either and the portfolio stats are inferior by a wide margin. A fund that had 3/4 the upside of the others and a much lower standard deviation would be interesting but that's not where RDMIX is. 

As I said at the top of this section, pulling off inside of one fund is pretty hard to do. Even the way I backtested it is not something that would be easy to recreate in a brokerage account, certainly not in an IRA and I am so far removed from the brokerage world that I don't know if mutual funds are marginable. Yes there are plenty of leveraged equity funds and a handful of leveraged bond funds which we've looked at quite a few times for anyone hell bent on doing this. 

Barron's had two different articles, here and here, that made very similar points about bonds with duration surprisingly going down in price (up in yield) after the FOMC announcement on Wednesday. The implication maybe being that bonds were expected to go up in price? If there are more rate cuts coming and if the curve is going to normalize, it's not clear that longer term bond yields are going to go down. They might not go up, I don't know, but the path isn't necessarily down. Based on the Barron's articles, investors are then left trying to guess what to do now. The two articles this week seemed to be cautionary about buying the middle of curve and further out and as one of the comments pointed out, always read the comments, last week Barron's was positive on this slice of the bond market.  

I think the articles make the point that we have been making here repeatedly for ages which is that bond duration has become a source of unreliable volatility and is now far less effective at helping to manage equity volatility. 

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.