The ReturnStacked guys aren't the only ones talking about portable alpha lately. This paper from Aspect Capital has some interesting thoughts. First, was a bit of a history lesson covering the failure of the portable alpha strategy during the Financial Crisis.
The big idea in simple terms is to add something that offers the potential to outperform the basic building blocks of stocks and bonds and do so via leverage. So adding a potential alpha source on top of beta (the basic building blocks). If at the start of the year, someone put 100% into the Vanguard Balanced Index Fund (VBAIX) as a proxy for a 60/40 portfolio, then to employ a portable alpha strategy, they could use leverage to add something to hopefully make it additive to returns. If someone leveraged up by 20% to buy Intel (INTC), they'd be underperforming YTD up 6.24% versus up 17% because Intel is down 59% this year. If they had levered up to buy MicroStrategy (MSTR), they'd be pretty happy up 118% because MSTR is up 550% this year.
Imagine the Intel scenario of down 59% on top of VBAIX dropping 16% in 2022. The way portable used to primarily be implemented was to leverage up with correlated assets and it ended up going very badly in 2008 when equities dropped 40%. It has evolved now to move away from leveraging up, moving closer to leveraging down as we've described it but not quite. It still leverages up but it adds diversifiers and the Aspect Capital paper notes that they believe managed futures is the best way to employ portable alpha.
Aspect tries to find the optimal leveraged allocation to managed futures on top of the "normal" beta portfolio. By their work 30% leverage into managed futures or 40% leverage into managed futures both offer compelling metrics toward being optimal.
Over the long term, the 40 or 30% allocations to managed futures on top of VBAIX added a little over 100 basis points of return per year with roughly the same standard deviation and slightly better Sharpe Ratios. Most of the improved return can be attributed to 2022. Managed futures did what investors who own it, hope it will do that year. If we stop that backtest at the end of 2021, the two levered portfolios outperformed by five and four basis points respectively, each with noticeably higher standard deviations and lower Sharpe Ratios.
Then I threw in an unlevered 90/10 mix. You can decide for yourself whether that adds value or not but it's at least in the ballpark without the risk of leverage. The Aspect paper mentions the risk sort of. They mention it without acknowledging it. From page 6, "Because managed futures can benefit from both rising and falling markets, so long as trends present themselves..." What if trends don't present themselves, meaning what if they don't persist? What if they are choppy with the occasional whipsaw like the last year and a half?
It's not a reasonable probability that managed futures would fall 60% the way INTC has this year, but there is nothing that says managed futures must go up when stocks go down. Yes, they probably will but in terms we've discussed recently, managed futures is not a first responder like an inverse fund, tail risk or certain VIX products. There's no direct cause and effect with managed futures like there is with an inverse fund. The risk to 40% or 30% of managed futures via leverage is that in a year like 2008, instead of going up like they "should," managed futures drops 15 or 20%. In 2008, VBAIX was down 23%. A 20% drop in managed futures that is leveraged to a 40% weight would have added another 800 basis points to the decline (simple math).
The risk/reward in this example doesn't seem worth it to me.
For more leverage, here's the highlight of a filing as Tweeted by Eric Balchunas from a firm he called Quantify Chaos. There's a company called Quantify Funds which runs the STKD Bitcoin and Gold ETF (BTGD). They would seem to be connected somehow but for now, look at the heat coming off that picture, but don't look too long.
The comments obviously had a field day with this but I can see an application of this idea. A tiny slice of the portfolio into one of these, provided there was a fund with two names that you liked, could be a way to allocate to asymmetry.
I've told this 100 times but two connections for me to asymmetry or barbelling. The first from when I worked at Fisher Investments in 2002. Two of the smarter guys there were intrigued by the notion that through the 90's an allocation of 2% short Nikkei Futures and 98% cash equaled the return of the S&P 500. As I've said, I have no idea if they were correct but the idea of getting a market equaling return with so little capital at risk is fascinating. Then a few years later, Nassim Taleb started to talk about taking extreme risk with 10% of the portfolio and the rest in T-bills.
We just looked at this in a slightly different context and the implication is not that it is easy to pick the next Nvidia or whatever but someone so inclined can put in the work, draw some conclusions and make small allocations that either work out or not. If it works out, see the MSTR example above. If it doesn't work out, the impact on the portfolio would be small.
The above do not rebalance with the idea being, to let the asymmetric potential really work or allow it to crap out. In Portfolio 1, I chose one stock that is up a ton and another that has lagged behind the S&P 500 considerably. Going 1 for 2 in this context might be unrealistic but going 2 for 2 would be very unrealistic.
5% each into Tesla and Qualcom, the rest in T-bills pretty much equaled the returns of the VBAIX albeit with quite a bit more volatility. I'd put an asterisk by the volatility number because of how little of the original capital was exposed to risk. That may not resonate with you but that's sort of the whole point of barbelling. It's constructive if you allocate down to the sector level, or narrower than that, to realize that there's some variation of the Pareto Principle driving portfolio returns.
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.
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