Uncompensated Complexity

Eric Crittenden sat for the Algorithmic Advantage podcast, it was about an hour and twenty minutes and covered a lot of ground. Crittenden manages the Standpoint Multi-Asset Fund (BLNDX/REMIX) which I've owned personally and for clients pretty much since the fund listed. 

There were some great points made to share and explore. The first point is that I think he validated a point I've been making for many years about managed futures and the importance of T-bill yields to the funds in the space. Most the of the managed futures funds are in treasury bills which collateralize the futures program. A question I raised more than ten years with a hedge fund data wonk was isn't yield on the T-bills a huge contributor? Yielding a half of a percent versus 4-5% would seem to matter a lot. I've been routinely told no when I've asked several people but I think Eric was saying it does matter, it is at least a useful contributor to the strategy.

The story behind the founding of the strategy underlying BLNDX and then the fund itself has a very long runway that you can check out for yourself on the podcast but the asset mix that led to BLNDX is what he thinks is the optimal portfolio based on many years of research. He believes it provides the best chance for an "acceptable" real return in all market conditions. That gives some good color on his use of the term "all-weather" to describe the strategy.

Eric also acknowledged how difficult it is to hold managed futures from week to week and month to month. This makes sense. It is a diversifier with the tendency of being negatively correlated to equities. Equities being the thing that goes up the most, most of the time, a strategy that tends to be negatively correlated to the thing going up most of the time will of course be difficult to hold. We appear to be in a stretch right now where that is true. Being difficult to hold probably applies to most alternative strategies which is a crucial building block for understanding what diversification really is. As Jason Buck has said, if you're really diversified then you have at least one holding that makes you want to puke. 

He articulated the asset mix of his optimal portfolio in a way that I hadn't heard him discuss before. BLNDX is 50% equities and then a range of managed futures of 50 to as much as 100%. But then he talked about T-bills being part of the mix too which of course they are and always have been. He didn't quantify the equities/managed futures/T-bill mix from his research so I took a guess and the results are interesting. 

The 25/25/50 blend did not keep up with BLNDX but it did offer a real return with very little volatility. Going back ten years, 25/25/50 compounded at 5.69% with a standard deviation of 5.73% versus 8.41% growth and a standard deviation of 10.27% for VBAIX. The ten year numbers for 50% VOO/50% AQMIX were 8.85% and 7.76% respectively. 

The most interesting part of the podcast was when he talked about getting rid of uncompensated complexity. This connects with two things we talk about here. First is my description of building a portfolio comprised of simplicity, hedged with a little complexity as well as assessing whether a strategy delivers on the expectation being set. The now closed Simplify Tail Risk ETF (CYA) blew up very quickly. I believe it was done in by the VIX portion of its strategy but either way I would say it never lived up to the expectation it set. Simplify has a fund that owns the S&P 500 with a put option overlay that somehow went down more than the S&P 500 in 2022. Same story, didn't meet expectations, these are examples of uncompensated complexity.

Above are two more funds that I don't believe meet the expectation they are setting, both compared to VBAIX. FIG, the blue line, "is a modern take on the balanced portfolio, built to help navigate today’s toughest asset allocation challenges." The Risk Parity ETF (RPAR), the pink line, "Seeks to generate positive returns during periods of economic growth, preserve capital during periods of economic contraction, and preserve real rates of return during periods of heightened inflation." Ok, how's that going? How soon before these should start to work? I don't know about FIG but I thin RPAR might have been an implementation of a successful backtest that did not look forward to see that bonds with duration were going to be a big problem. Typically, risk parity which is what RPAR is, loads up on bonds. 

Checking in on catastrophe bonds, I thought the following two screenshots would useful learning tools. First is sort of an asset allocation picture from the Pioneer Cat Bond Fund (CBYYX).

I'm a little surprised how much was exposed to Florida hurricanes but that is obviously where much of the threat lies. The next screenshot lists some of the positions in the Ambassador Fund (EMPIX) which I am test driving in one of my accounts for possible use for clients.

Two things to note here. Cat bonds are not really bonds in the manner most people think. They are T-bills with what amounts to a note or a rider bundled in to add up to a higher yield. The other thing is I highlighted the different reinsurance companies transferring the risk via the bonds. On other pages of the holdings there are duplicates of reinsurers but there is work done by the fund managers to try to diversify issuers. The funds are designed to spread the risk very broadly but obviously, anything can happen at anytime. The yields are high, there is a risk tradeoff to consider which is an argument to keep any sort of weighting small. 

Finally, if you're interested in the 351 Exchange I mentioned the other day where you swap your portfolio for shares in an ETF to capture tax efficiency, here's a good primer from Cambria who is looking to bring this to market. I got a couple of the conclusions wrong about tax basis and that there will be requirement to "buy in" with a diversified portfolio as oppose to just a position in low basis stock. It's not looking like I will have any clients for whom this makes sense but will keep trying to take in more information.

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