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.