Chopping Off The Tail

Ryan Kirlin had a fantastic one-liner to describe the use of liquid alternatives.

I think it's a different way of saying what we say here about constructing a portfolio with a lot of simplicity and hedging with a little complexity. Alts like merger arbitrage or catastrophe bonds are not "return getters." In a portfolio that goes narrower than broad index funds, even some of the equity holdings will not really be return getters. 

Most clients own Johnson & Johnson (JNJ). I've owned it for clients for just over 20 years. 

I would not call JNJ a return getter. It tracked sort of close for most of the chart but the boxed areas show it going down quite a bit less than the index during declines. I should also note it was down much less than the index in the 2020 Pandemic Crash. That's generally the expectation/hope for what the stock will do. This year is sort of an outlier, testfo.io has JNJ up 25% this year versus 10% for the index. That sort of outperformance in an up market hasn't happened too many times and not what I would expect going forward.

We've talked about tech, as a narrower holding, being a source of return, or in Ryan's parlance, a return getter. Far more often than not, tech tends to outperform in up markets with the tradeoff being it will go down more in down markets. 

Something like client/personal holding BTAL or an inverse fund, maybe one of the tail risk funds depending on the environment are tools to "chop off" or at least mitigate some of the left tail. Left tail is a fancy term for extreme and typically negative events like the 2020 Pandemic Crash. We've also talked many times about client/personal holding CBOE in this context which has tended to trade as a proxy for the VIX Index during the last few left tail market events. 

Circling back to Kirlin, that Tweet is part of a thread where he linked to a paper that his firm published in 2016 about why it is not a fan of merger arbitrage. And here is Bloomberg's favorable coverage about why merger arb has gotten more attention from institutional shops lately. Long time readers might recall that I have owned the Merger Fund (MERFX/MERIX) for clients for a very long time. I am a believer in it as a very low beta diversifier. This century, it has only had one down year that was more than 100 basis points. 

Earlier in its existence though, it had a few large drawdowns. I would attribute larger drawdowns from 25-35 years ago to much higher interest rates. Financing something at 8% is a much larger headwind than financing something at 4%. There are also complexities related to spreads on deals with higher interest rates that can also make the strategy more volatile. The entire time I've been in the position, interest rates have been very low. Four-5% rates don't seem to be a problem but this might be a prompt to exit if rates take another meaningful leg higher. 

Speaking of low interest rates, for some odd reason I got a news alert about an article I wrote for TheStreet.com during the 2013 Taper Tantrum about avoiding bond funds with duration. It's pretty much the same conversation we've been having on this latest iteration of the blog for the last four years or so. The original blog where I wrote was called Random Roger's Big Picture (I hadn't heard of Barry Ritholtz yet). This anecdote about intermediate and longer rates not being high enough compensation at 3-5% all those years ago, longer actually, is a very big picture, long term theme and portfolios built with a lot of simplicity hedged with a little complexity is a very big picture, long term investing concept.

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.

Closed End Complexity

On Tuesday I sat in on a presentation about the Absolute CEF Opportunities Fund (ACEFX). I've known about closed end funds (CEFs) since the late 80's reading about them regularly in Barron's. Barron's still gives them some attention. It's a quirky space. There are only 455 CEFs. The quirk is that unlike mutual funds or ETFs, the number of shares is fixed (for the most part) so the market price can drift above or below the net asset value (NAV) of the fund's holdings. 

Back then, Thomas Herzfeld was the axe in the space and these days I think Boaz Weinstein from Saba Capital would have that title but there are a few other activists too and other types of managers including ACEFX. The managers of ACEFX have only been on the fund for a year and they inherited a dreadful track record so I have no idea whether the fund is a good one or not but the presentation was interesting.

Individual investors, they said, tend to buy CEFs for the yield. CEFs use leverage which magnifies the yield as well as the size of the drawdowns. Institutional investors are trying to capture a bunch of other types of trade beyond just sitting on them for the yield.

ACEFX listed out the various trades it looks for under its hood as follows.

Event Driven

• Rights offering-often leads to tradeable price movement
• Liquidity at NAV-occasionally funds close or offer to buy shares back at NAV
• Fund mergers-this would typically occur within the same fund family
• Large dividend changes-this too can lead to tradeable price movement

Relative Value

• Deep value names with a catalyst
• Volatile premium/discount valuations
• Sector funds (e.g., healthcare, master limited partnerships (“MLPs”), real estate investment trusts (“REITs”)
• CEFs trading at premiums, both long and short
• Relative dividend yield discounts versus peers
• Tax loss selling and the “January Effect” 

I thought the first CEF was Adams Express (ADX) which started in 1929 and has since changed its name to Adams Diversified Equity Fund. It turns out CEFs have been around since the 1800's. I really get a kick out the fact that something presumably so basic has evolved into a series of very complex strategies. 

I don't have much to add here, it's just a fun part of the market to look at. 

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.

Rebooting From Burnout

William Bernstein and Charlies McQuarrie posted a strange article to Advisor Perspectives saying that people do not spend less when they retire. They fixate on 30% as the spending cut that doesn't happen. 

Maybe it's me but I think the focus is more about not needing to fully replace income in retirement. I don't think people talk about flipping a switch to spending 30% less. They attribute part of the myth to mortgages, FICA and kids' tuition going away. They rightly say this doesn't all happen at once when we're 64 years and 11 months. 

Yes, FICA goes away as soon as earned income stops, that part is not myth. Can you square up being mortgage free before you retire? I could see where some folks would peg their retirement date to paying off the mortgage like maybe the mortgage will be paid off at 65 years and 2 months and so someone retires at 65 years an 8 months to war chest their first few months of retirement. The way the world has evolved, even if a new retiree is long past paying tuition bills, adult offspring could still be on the payroll (crude way to put it, I know). 

We've talked plenty of times about taking a bottoms up approach to working through expected spending needs and then revisiting periodically. Even if you're 70, have been successfully retired for 7 or 8 years I would do this. Is there visibility for something in your spending picture to change? The context could be favorable or negative. How resilient is your plan to some sort of negative and expensive surprise? 

I say it constantly here but I think the key to resiliency in retirement is having income streams beyond an investment portfolio and fallbacks and the planning for this needs to start early. I don't think I will retire from what I do but at some old age my practice will be more of a small income stream similar to how my Del Webb Foundation gig is shaping up, both of which by then would probably be smaller than the rental income from our Airbnb. 

As with a lot of things in life, the more you put into it (retirement planning) the more you will get out of it. 

Michael Kitces and Carl Richards looked at advisor burnout. If you're an advisor reading this and you have truly hung your own shingle that includes operating the business and doing compliance then yeah I could see burning out on that. I outsource all that thankfully but even the little bit of compliance reporting that we have to do is no fun so I get that. As far as the advisor and portfolio functions, I have nothing for any advisor who doesn't enjoy that part of it. Look at this excerpt from Matt Levine;

My theory of exchange-traded funds is that they are an easy way to package trades. Anyone — any broker or financial adviser or individual investor — can think up a trade, and there are infinite possibilities. “Buy Tesla stock” is a trade, and “borrow money to buy more Tesla stock” is a different trade, and “buy Tesla stock and also buy Ford stock” is a third trade, and “buy Tesla stock and short an equal dollar amount of Ford stock” is yet another trade, and “buy Tesla stock and also buy some Dogecoin,” and “buy Tesla stock and sell call options on Tesla,” and “buy Tesla stock and also put options on Tesla,” and “buy Tesla stock and buy puts and sell calls,” and “buy Tesla stock and buy puts and sell calls but with different strike prices,” and “buy Tesla stock on Mondays and sell it on Wednesdays,” and so on, a tedious infinite list of potential trades just involving Tesla.

That is a doozy of a paragraph but it isolates why the work is so much fun, you have the opportunity to always learn new things and not captured in that passage is the opportunity to help people, I mean really help someone figure something important out. No matter how long you work in the field, those two opportunities will always exist.  

To help with burnout, or as the guys said it might just be boredom, more generally, I would say regular, vigorous exercise can help as well as some sort activity that requires completely different thought processes. For me that is volunteer firefighting but there are infinite possibilities on this front to turn off being whatever your day job profession and then turn on your volunteer role. Both exercise and volunteering offer regular rebooting which I think can help with burnout. 

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.

Retirement At 58?

Let's start with Ben Steverman from Bloomberg doing some personal calculus on whether to buy a house or rent. As I read the article, it seems like Steverman might be in his early 40's, has never purchased a house (or condo) and has mixed feelings about it. I don't sense regret, I think he is genuinely unsure, leaning toward being ok with not having bought up to this point. 

It was of course always a no brainer to buy a house if possible but along the way, the no brainer argument eroded some. In many places now, if you run the numbers on buying versus renting, renting appears to be cheaper. 

Part of the argument against homeownership is that the total costs far exceed the price of the house. With a 30 year mortgage, the total interest paid over the loan term will exceed the price of the house. Invariably, there will be things that need to be fixed and things that need to be upgraded or replaced. There is of course property tax and insurance. Renters don't need to directly incur any of those costs. 

Rent will go up at some rate that is probably close to the rate of price inflation whereas a mortgage payment stays the same (in terms of principal and interest). In 2005, the US median home price was $232,000 and the prevailing 30 year mortgage rate was 5.8%. Assuming 20% down back then, the homeowner's payment would be $1322/mo. The median home price today is $410,000. Google says that the median rent in 2005 was $694 and now it is $1700.

I'm not big on everyone should either way, but this is a blog and I share opinions. A non-religious sort of parable that I think fits; a middle-aged guy tells a friend he's interested in learning Italian but he thinks it'll take five years before he could actually be proficient. The friend tells him that the five years are going to go by no matter what. 

Someone who made a decision about buying versus renting in 2005, well the 20 years went by and using the 2005 example, the mortgage balance is down to $96,000 so the equity is $314,000 that they wouldn't have accrued from renting. There's an argument about renting allowing people to save/invest more (extra) money which I have trouble believing this is something that people do, somehow investing extra money. Please leave a comment if you are on the other side of that idea. 

That equity is optionality. Regardless of the dollar and cents of the buy/rent decision 20 years ago, the homeowner has $314,000 or optionality on top of what is hopefully a healthy 401k balance. 

Now to the affordability problem in big cities which Allison Schrager touched on with her own personal account from about 20 years ago coincidentally when she was faced with talking her way out of moving from New York City to Austin. Her article was more about whether large cities are too expensive for people irrespective of buying a house or condo. 

I have no idea whether the "era of the big city might be over" as she asserts in the title as she admits that she might have been better off moving to Austin 20 years ago. I've never been to Austin, but looking at a couple of cost metrics, it appears to be a second tier city in terms of cost of living (not making a value judgement, this is simply dollars and cents). It has a big population but the average home price is just a fraction of places like Boston or the Bay Area. 

As someone who has lived in very small city for most of my adult life, there are advantages and disadvantages. It used to be very cheap here to buy a house but that is no more. The way the internet has evolved it has become much easier to make a living remotely than when we got here in 2002. Our population growth has sort of overwhelmed the road system, there is now a lot of traffic in Prescott and Prescott Valley but it's nothing like a truly big city. The population of our county is only 250,000 but it's heavily concentrated in the Prescott area. 

Even if not true of Prescott anymore, there are plenty of medium and smaller cities where homeownership is far more accessible. If someone can enjoy a smaller and less expensive city and make a good living thanks to remote working, buying versus renting might be less of a dilemma. Places like Chattanooga and Tucson often show up favorably on lists of desirable places to live and average home prices in both places are in the $300's. Where are two, there must be others.

Now, connecting all that to a Tweet from Unusual Whales about a CNBC survey that concluded "retirement age should be 58." The comments were fantastic, ranging from very smart to very dumb, it should be easy to retire (financially) to people believing they will never have enough, retirement should be earlier to we should never retire for several different reasons, there were assumptions about whether Social Security would or would not start at that age and of course comments about loving what you do being akin to already being retired. 

Again, no everyone should from me but for people who do want to retire, the optionality created by building up home equity over the course of 20 or 30 years makes whatever they have in mind easier. Maybe the best plan for someone is to stay put. Ok, that mortgage will be paid off at some point dropping their cost of living. 

My comments about Chattanooga and Tucson create a path to downsizing working out pretty well, financially. To Schrager and working in NYC. Someone working there in 2005 might have bought in Hoboken, NJ and paid a median price of about $300,000 back then. Maybe that was a bit of a financial stretch and now in 2025 they don't have a ton saved in 401ks but they have some. If this person is now of retirement age, they could sell for a median price of $920,000, downsize to Chattanooga for $337,000 and have a good bit left over to fund retirement. 

If this person had been renting in Hoboken the whole time, they'd have started paying $822 in 2005, they'd now be paying $3800 and not have all that retirement optionality with that equity. 

Weigh in if you disagree but I think the discussion between renting versus buying is more of a shorter term issue, appearing to be cheaper...for now. A gap in my thinking would be people who expect to move frequently but I don't know the prevalence of that cohort, is that common? If someone expects to move in five years then buying a house/condo may not make sense but I'm hard pressed to see where someone is better off 20 years later by having decided to rent. 

All the numbers I pulled for this post were from Google Gemini and the mortgage calculations were from mortgagecalculator.org. That was a fun one!

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.

My Dude, No

The Barron's cover story was about the potential for private equity and private credit to be available in 401k plans. If you have read anything about this story, it probably included something to the effect of this being good for the asset managers and how they've been trying to get into this market for a while.

I think is a monumentally bad idea. The odds of this ending badly are very high. Contradiction alert, they probably should be available in plans, I am not a fan being denied access by someone else but it is up to us figure out they are looking for bagholders and to have the sense to avoid putting our 401k money into private equity. One of the comments on the Barron's article said, "if it's such a good deal, why are they offering it to you?" That was pretty much what I was taught about IPOs when I first started at Lehman Brothers in 1989. 

Does anyone think the asset managers have an altruistic ambition to level the playing field for the individual investor? My dude, no. If you gots to have it, skip one contribution and put that money into one of the asset managers benefitting from the fee income.

After looking at the results of a couple of the ReturnStacked ETFs, a reader asked about the Return Stacked Global Stocks & Bonds ETF (RSSB). 

I think the replication is pretty accurate and being short CASHX should address most of the cost of financing. The results are within a few basis points of being identical. For someone interest in portable alpha and wanting to take on a little duration in a treasury portfolio, it seems to work. 

Sorry, short post today.

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.

Dissecting Derivative Income

A colleague asked about the iShares 20+ Year Treasury Bond Buywrite Strategy ETF (TLTW) which we've looked at a couple of times although it has been a while. TLTW owns TLT and sells covered calls. Yahoo shows the yield to be 10% so it's high yielding alright but not a crazy high yielder like some of the YieldMax or GraniteShares. 

I spelled it out for him in terms of TLT pretty much having equity volatility without equity upside, the covered calls capping whatever upside there might be which you can see a great example of in the chart and that there are plenty of high yielders that either have a shot of going up or at least mostly keeping with the distributions. TLTW is not one that has come anywhere close to keeping up with the distributions.

The area inside the green circle shows TLT going up nicely but TLTW doesn't get the benefit of that lift. I threw in BRW which is a closed end fund of funds that is not in my ownership universe but one we've used for blogging purposes. It yields 12% per Yahoo and of course may not go up but it does offer the opportunity to go up that I don't believe is available with TLTW and BRW has track record for trading sideways meaning it has often kept up with the distributions. Keeping up with the distributions for something that yields 8-12% is a pretty good outcome. 

The next chart is interesting.

It's a 20 year chart of the SPDR S&P 500 ETF compared to a stock that is not in the tech sector and is not Amazon. Other than that it doesn't matter which company it is. The point to be made here is one of ergodicity. There have been painful declines along the way, clearly, but it's never been a stock in jeopardy of going under. The declines mostly correspond to declines in the broad market, not terrible news from the company. Terrible news doesn't mean an earnings miss, there probably have been quite a few over the years, I mean something serious to worry about like a drug becoming obsolete or like Kodak film no longer being needed. Other than shaving down if the position got too big, there would have been no reason to sell the name even in that awful looking decline in 2022. 

I saw a Tweet promoting the Return Stacked Bonds & Managed Futures ETF (RSBT). Similar to yesterday looking at equities plus managed futures, this is a corresponding study using RSBT compared to 100% AGG paired with the same four managed futures funds that we used to study RSST. 

We spend a lot of time trying to dissect complexity, trying to assess the value of various funds and/or strategies. Some work well and some really don't work at all. No one suggests putting 100% into RSBT but the study is apples to apples and as we've been saying, the short position in CASHX speaks to the point of the cost to finance the position even if not to the exact basis point. 

It's not like this backtest was skewed by an outlier year even. RSBT has been the worst of the five in each year available to study.

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 Risk Of Too Much In Fixed Income

Vanguard maintains what it calls its time varying asset allocation portfolio, it's a model ETF portfolio. The news from last month is that the model is allocating 70% to bonds versus their 60/40 benchmark. 

Looking forward, Vanguard expects equities to underperform due to what they view as a "low equity risk premium." They could turn out to be correct about equities not doing as well as they usually do. If you click on the link, it will say they ten year expectations for bond returns are 5.5% versus 5.2% for equities. 

Portfolio 1 uses mostly Vanguard funds except for AGG to replicate their idea. Portfolio 2 is fixed income proxies that we talk about all the time and Portfolio 3 is the same as Portfolio 2 but replaces their equity suggestions with the S&P 500.

The numbers on what they are suggesting going forward have been pretty brutal but they could be right. There are really some enormous bets in their portfolio though. Value and small cap have lagged so badly for so long that picking them now as the time they will do well or at least better than large cap is really just a guess. There are theories about small cap lagging related to the prevalence of IPOs starting out as large cap stocks, bypassing the small and mid cap indexes which in the past were a source of a good amount of those indexes' growth. Small cap indexes no longer get the benefit of those stocks. 

Small caps used to lead early cycle and that hasn't happened the way it used to. There used to be fairly predictable points in the economic cycle, related in part to yield curve dynamics, where value tended to outperform growth and again, that's not working in the same manner. 

With that fixed income allocation, Vanguard is counting on rates going down some to hit that 5.5% growth assumption. Again, they might turn out to be correct but relying on getting that kind of call on interest rates correct is a tough way to make a living. 

We pretty much go over this a couple of times a week about there being plenty of ways to sub in other the attributes of what I think people want from fixed income without the volatility and the need to be right about interest rates that goes with the funds Vanguard has chosen. Of course the funds we talk about here have their own risks as indicated by the past results but the impact of something going seriously wrong with one of them can be mitigated by proper sizing of exposures that are vulnerable to different things. 

If someone really wanted to implement Vanguard's 30/70 portfolio, they could include some short dated individual issues (avoids interest rate risk) and add in a couple more funds to get the weightings to less than the 10% I simplistically put together. And while I am not sure I would rely on value and small cap equities, I would blend in some foreign exposure with the S&P 500.

Simplify filed for an ETF that will leverage up to own 100% US equities and 100% managed futures in a similar (identical?) manner as ReturnStacked US Stocks US Stocks & Managed Futures ETF (RSST). 

No one has suggested 100% into RSST but this comparison supports the point of why I have been so skeptical. The other four comparisons are short CASHX so there is something of an embedded financing cost as we looked at the other day even if it is not precise. 

Doing the same combo with KMLM did worse than RSST and I should note that client and personal holding BLNDX has had a very rough go for a while. 

If you read content from ReturnStacked, it's great stuff if you don't, they often talk about 20% allocations to managed futures. This paper dated June 25th looks at building a portfolio with 30% managed futures of course stacking the exposure on top of 60/40. Presumably the way to do this is with 30% in a plain vanilla equity index fund, 40% in a plan vanilla bond fund and 30% in RSST. 

Portfolio 1 is taken from the paper with 30% VOO, 40% AGG and 30% RSST so it is 60/40 with 30% managed futures added on top. The other four are 60% VOO, 40% AGG, 30% the managed futures fund named in the title of the portfolio and -30% in CASHX which again should account for most of the financing cost. 

BLNDX, rough as it has been for a while, is a low single digit weighting. When it is working which has been far more often than not, a little goes a long way. Great backtests notwithstanding, 20%, let alone 30%, in managed futures doesn't make a lick of sense to me.

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.

Come For The Inflation Protection, Stay For The Absolute Return

A couple of months ago we gave a quick mention to the new WisdomTree Inflation Plus Fund (WTIP). Two months isn't really enough time to draw a conclusion but I thought it would be fun to circle back for a closer look at the idea even if not the fund yet. WTIP uses leverage to blend together a lot of TIPS, long/short commodities and a little bit in crypto. The allocations I found in June are a little different than what is in there now, they obviously must have some leeway.

The positions show 67% in TIPS, 28% long commodities, 26% short commodities, 7% cash and 4% in crypto. It will always be long gold and silver and right now "precious metals" show long 8.85%. Using the current allocation, I built the following. 

STIP is short dated TIPS which is a pure application of the WTIP idea but STIP compounded almost identically to inflation in the period backtested due primarily to a 5% decline in 2022 when inflation was positive by a little over 2%. So STIP provided no real, positive return. If you think you might want to replicate WTIP, just use individual TIPS, not an ETF. I used managed futures because it is long and short commodities but it's not a perfect substitute because the strategy goes long and short other markets too. 

The back test only goes back to the beginning of 2018 because before that, Bitcoin had some fast, massive rallies that I don't think can be repeated. I don't know if the result from early 2018 on can be repeated but it's plausible. 

The results are interesting. Inflation for the same period compounded at 3.60% so all three had a pretty good positive real return. For a little context, earlier in the year quite a few pundits suggested TIPS as being attractive for offering a real return of 2% above inflation. I'm relaying that third hand, it was not a first hand observation. 

All three versions of the WTIP replication pull in some other attributes that we often talk about here. The first one is that the growth is barbelled into the Bitcoin allocation. Bitcoin compounded at 31% in the period tested. Roughly 40-45% of the gains in each of the three replications is attributable to the lift in Bitcoin. Continuing to go up a lot, on a relative basis, might happen but is 31% something that can repeat? Again it's plausible but not a certainty by any stretch.

I also think the overall result is absolute returnish. There's some dispersion year to year but the volatility is quite low. None them should be expected to look like equities, the S&P 500 compounded at 13.67% during the period tested. Although the results look pretty good compared to VBAIX, I don't think that would stand up over a longer timeframe due to having no equity exposure. 

If Bitcoin simply meandered along, not going up a lot, it would reduce the various growth rates of the backtests by about 300 basis points. By meander, I mean trade sideways not go down a ton. Even then, the real return versus inflation would still be decent, volatility would compress even further making it an easy ride for someone able to resign themselves to the fact that this will not keep up with equities. Another thought would be to try to find other opportunities for asymmetric returns to swap in for Bitcoin or to diversify the 4% crypto sleeve with Bitcoin. 

I think the replications are very interesting even if WisdomTree were to look at them and say bruh, not even close. 

I'll wrap up with a quick check in on the RISR/plain vanilla MBS fund pairing we've explored several times. As a reminder, the idea is that 50/50 RISR/one of the MBS funds would offset into an absolute return with very little volatility. Yesterday it worked.

And was working mid-day Tuesday.

I track these daily and I would say it probably works on a daily basis about 70% of the time. The idea is fascinating but it might be too big of a leap of faith. 

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.

Build Your Own Endowment Portfolio, Really

For the last couple of weeks, I've been watching a series of videos for my involvement with the Del E Webb Foundation. I think these videos get me out of going to in person presentations in Columbus in November, so time well spent! The curriculum is mostly aimed at new foundation board members. One of the videos had to do with investment management and based on some survey this was the common allocation.

This is a lot closer to what an individual might do in their portfolio versus someone like Harvard or Yale and what they have been doing for the last ten or 15 years which has far more in various illiquid pools of capital. Per the presenter of the video, alternative strategies were hedge funds and private equity. 

The "average" above can be very simply constructed and meet the idea we talk about regularly, a lot of simplicity hedged with a little complexity.

More clients own GLDM, as do I, but a lot of the accounts I subadvise came in with GLD. ACWX is not in the main portfolio but smaller accounts own it. 

While I would definitely want to sub out AGG for something else, the smaller exposure to AGG-like fixed income versus the 40% in VBAIX certainly helps. I used QSPIX for hedge fund replication which is the one bit of complexity in Portfolio 1. Someone might think the addition of merger arb and catastrophe bonds in Portfolio 2 is also complex which is fair.

I think the replications work versus VBAIX primarily because they have a "normal" weighting in plain vanilla equities, just above 60%. As I mentioned, swapping some AGG exposure matters too. 

There's no reason that a large endowment/foundation can't have a lot more allocated to public equities than they currently have, talking Harvard and Yale. If you are not familiar with NVPERS, it's the Nevada State pension system. Go check them out. It manages billions and has something like 88% in index funds, the rest in private placements. A lot of simplicity, hedged with a little complexity although hedged might be the wrong word. Either way, the overwhelming majority is allocated to simplicity. 

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.

Bro, What Does That Even Mean?

Richard Ennis had a short post about what he called scattershot diversification on the part of endowments and foundations. The last paragraph of the post as follows.

There is nothing elegant about portfolio construction today. In fact, it seems almost primitive. Institutions own a jumble of equity things — nearly countless, largely illiquid and beyond their control. And they diversify via costly managed portfolios, something finance theorists frown upon as not being cost-effective. This is the story of scattershot diversification.

His use of the word elegant is the catalyst for this post. Maybe I should understand that but I don't. The rest of the passage fills it in some. Copilot was able to add some color.

Plain vanilla 60/40 is elegant, Copilot says, because it is simple. Factor-based portfolio construction is elegant because it is "based on academic research." A couple of other "elegant" examples are core and satellite and even risk parity but it notes that with risk parity, elegance can erode. 

Things like private placements are inelegant due to the expense, lack of transparency and lack of simplicity. Ennis does not believe the use of alternatives is applied scientifically, he believes that the way endowment portfolios are constructed, that they are over diversified. 

I guess the first point of portfolio construction is that any portfolio you build and manage for yourself, or that you outsource to an advisor, has to be one that you can live with. The second priority might be that there is some reasonable basis to believe it can do what you need it to do. Putting 95% in T-bills and 5% into a soda stock is not going to provide much opportunity for growth if that is what the end user needs. Maybe, it will keep up with CPI or even do a little better but that allocation is about low risk capital preservation. 

All we ever said about the huge allocation to various types of private equity/VC pools that endowments have had for a while has been along the lines of they must think they need that but that's not going to work here. Replicating isn't so easy either for anyone interested in trying. Now with all the craziness between universities and the federal government causing the endowments to try to sell down some of these investments, maybe these allocations were not something they could live with after all. 

My belief in a lot of simplicity, hedged with a little complexity can scale up to any size. Maybe for an endowment the size of the Harvard Management Company, some of the complexity piece (like managed futures, macro or arbitrages) should be in private pools but 90% in simple exchanged traded assets are obviously plenty liquid which is a problem that Harvard reportedly has needing to sell some of its illiquid holdings and looking a serious discounts to get it done. 

I still don't fully understand the use of the word elegant for having an overly complex portfolio or having a portfolio that turned out to not meet the end user's need but that's ok. 

A quick follow up, more of a coincidence actually. Early on Sunday we had a small project at one of the fire department substations where we house a water tender. The logs around the perimeter of the driveway had rotted and needed to be replaced for erosion control. The rotted logs had been removed, freshly cut logs had been left and we just need to place them and secure them in with some rebar. 

There were four of us and not of my doing the conversation turned to retirement issues related to sustainable withdrawal rates for the most part. One of the four though is younger, he's 47, only been in Walker for a couple of years and is working remotely. He talked about retiring in 20 years but somewhere he picked up a retirement number that sounds very big to him. Whether it really is big or not isn't the point, it seems big to him. 

I told him the number is meaningless. That in the time I've been in Walker I've seen people make it because there was no alternative, they have to make it. "You'll make it work one way or another because you have to, don't worry about that number." He understood the point. I'm not sure it made him feel better, but he understood. 

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 Retirement Crisis Is Overblown?

Yahoo has an article up that says the retirement crisis is way overblown. The short version from experts cited in the article is that the narrative simply does not show up in the Social Security Administration data and thus is incorrect. 

Chances are that the audience for this blog and plenty of other advisors and their clients may not have a great grasp of what the real story is, I certainly don't feel any great insight into the truth. One observation I have made in the past, albeit with a limited sample size, is that one way or another, people make it work because they have to, there is no alternative. 

Someone who is very undersaved versus where they should be at their age reasonably would view it as a crisis, someone who is on pace or ahead of the pace may not see it as a crisis. 

The comments on this one are worth reading. One reader suggested stress testing your numbers based on the following.

• Stock market decline of 20-40%

• Housing crash of 20-40% of value

• hyperinflation of 10-40% (depending on product)

• Loss of valuation of the dollar by 20-40%

Could your plan withstand all of these, he asked? He painted a very rosy scenario for his particulars and said that he is not totally in the clear against all four.

The idea of stress testing is smart but I am not sure I would use the reader's list. If you still believe in American capitalism (I do), there will be bear markets in our future but markets will recover over some time period. All you need to do is not panic. Stress testing or mitigating an adverse sequence of returns in your first couple of years of retirement as we discussed the other day is useful though. 

Would a decline in housing prices impact your retirement? Some people will say yes but some will say no. My hope at 59 is to be able to stay here until the end or at least until we are very old which might mean 30 years. Our house is paid for so I'm not sure what the impact would be if the number on Zillow went down a ton. Again, for some people it will matter.

The US issues debt in its own currency so true hyperinflation is off the table but a real problem with price inflation is certainly feasible. Price inflation has been a problem for several things for awhile, most notably for us with homeowners insurance and health insurance. I bought a sleeve of 18 hamburger patties at Costco and I was stunned that it cost $29. Where you have noticed unreasonable price increases, where is your ceiling? Is there a point you would go without? If we went without homeowners insurance, I would invest money to make our fire suppression setup more robust. We have a 2500 gallon tank, some hose and a nozzle. If at some point insurance becomes a problem, I might get another 2500 gallon tank, an inline pump and some rainbird sprinklers for example. That's more about planning I guess than stress testing. 

I don't think the dollar could go down by that much but something nasty that causes pain is feasible. Owning gold is something that should help, I say should but that is not assured. The idea of a dollar devaluation seems to tie in with a bad things happening with price inflation.

I would add to the reader's list to stress test not a crash in stocks but more like a prolonged malaise where markets compound at a much lower rate than "normal" and I would stress test a large cut to Social Security which we've talked about several times before. 

Here is a theory about Social Security being cut that I thought of today. Using my numbers, at 59 now, my age 67 amount is $3849/mo in today's dollars. I am slated to get that amount in 2033 if I took it at that age. Between now and then, that number will get inched up every year by some COLA amount. To make the example simple, assume that for the next eight years until I am 67, the COLA compounds at 2.5% per year. That would take $3849 up to $4251. Applying a 23% haircut to what would be $4251 would mean getting $3273/mo. Yes 23% from $4251 but only 15% from what my number as of today. 

Ok, so there's probably some mental accounting in there but a 23% cut wouldn't apply to the number you see on your statement today.

We talk regularly about what I think could be thought of as a different type of stress test. What happens if your Plan A simply unravels because your hand is forced at work any number of any other things that might be relevant. 

I've framed this as having a timeline for my Plan A which really only involves taking Social Security at 70 and continuing to work, I like my job and don't intend to retire. One thing that could derail anyone's Plan A is that they have a change of heart, they just decide that whatever they had in mind is no longer for them. I've seen this some with fire acquaintances trying to figure out what comes next. I know one or two people with Federal jobs who thought they'd still be working but now they don't know. 

We have talked before about thinking in terms of getting to the next milestone, can you make it to penalty-free IRA withdrawals if there is some sort of job problem, then could you make it to early Social Security at 62? After that I suppose age 67, if that is your full retirement age for Social Security. Sixty seven may not be relevant if someone's Plan A is to take SS at some earlier age. 

Between having a problem at work (if that happens to you) and being able to execute whatever you have in mind for Plan A is a time period to be reckoned with. Maybe that's between 60 and 66. For me, that would be between 59 and 70. Assuming all continues to go well, the time period obviously gets shorter and the potential problem gets smaller. 

Smaller problems is a big motivation for me which is why so many of these posts focus on figuring these things out early on. Part of my idea of financial independence is being able to weather a job loss. One firm I was at got shut down and you know I don't know how lucky we were or not to land somewhere else right away. Maybe we were very lucky or maybe it was no big deal, I don't really know but my wife and I would have been far from desperate if it hadn't worked out. That's not about being loaded, we're not, we're pretty comfortable. The form of financial independence I am describing is about planning, putting in some effort and living below our means which are all things that most people can have some control over. 

Take Their Idea To Build Your Own Portfolio

The ReturnStacked guys Tweeted out promoting the ReturnStacked Balanced Allocation & Systematic Macro Fund (RDMIX) which we've looked at several times in the past, most recently in January. I believe the fund is on it's third strategy with the most recent change happening in January coincident to the linked post. 

The strategy is described as "for every $1 invested, RDMIX aims to provide $1 of exposure to a U.S. balanced allocation and $1 of exposure to a systematic macro strategy." They use IVV for equities and AGG plus ten year treasury futures for fixed income exposure. 

I think of the strategy underlying the fund as being quadrantish which is why the comparison to PRPFX. Either way, it's been a rough go for the latest strategy change. I've seen a Tweet or two where one of the ReturnStacked guys said (paraphrasing) if you're going to be critical of their funds, your critique should include a mention of the embedded costs of financing the leverage. Simplistically speaking, futures offer access with leverage and there is a cost to the leverage, a financing cost kind of like margin in a brokerage account but with futures, the leverage is paid for in the pricing of the derivatives. 

How much of the performance is attributable to the financing cost? If it's minimal then that would lead to execution questions, is what RDMIX tries to do a valid strategy or are they somehow doing it incorrectly? If the financing cost is a big obstacle then that would lead to questions about whether using leverage is just a bad idea. I suspect it is the former based on the following.

I replicated the strategy this way. QGMIX is in my ownership universe.

If the cost of financing is tied to a T-bill yield of 4%+/- and the backtest runs through yesterday, then simplistically, the cost to carry the leverage could be expressed as 225/365 of 4% or 2.46%. Not exact, but a framework. FWIW, testfol.io says that CASHX' total return (just yield) is 2.58% so shorting it might account for the financing cost in the return of 8.23% for the leveraged replication versus 5.4% for the unleveraged replication. The sum of CASHX and the levered replication is 10.81% almost exactly double the result of the unleveraged replication so I think we're doing a reasonable job, even if not precise to the basis point, of accounting for the financing cost. 

Rational ReSolve took over management of RDMIX on February 27, 2018 and ran it as a capital efficient macro fund and then changed it to tie into the ReturnStacked suite of funds earlier this year. 

This is not apples to apples before 2025 but it captures the struggles of RDMIX and also makes the argument that the premise underlying the current version of RDMIX is valid. It only has 25% in equities so it shouldn't be expected to keep up with 60/40 but the volatility attributes are attractive and the return above inflation also looks good for a non-equity centric portfolio. 

Any sort of real life application should have several funds for the macro sleeve. Having, in the unlevered version, 50% in one alt seems like a terrible idea to me. I would also want to swap out AGG-like exposure and ten year treasury exposure with less volatile fixed income holdings. 

Trying a closer to real life application with the following as Portfolio 3;

MERIX and BLNDX are in my ownership universe.

It lags behind PRPFX by 67 basis points annually but that much of a drop off in volatility and smaller drawdowns is probably worth it. At least the Sharpe Ratio thinks so. Again, this is RDMIX' concept. It's valid so this could be thought of as taking a bit of someone else's process to create your own process. 

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 Fragile Decade"

Retirement Researcher wrote about what it calls The Fragile Decade with the primary focus being sequence of return risk of poor market returns in the first few years of retirement. You know this already but retiring on December 31, 2007 could have created a serious headwind for a sustainable retirement versus retiring two years later. 

The blog post suggested four ways to mitigate sequence of return risk in a scenario like retiring on 12/31/2007.

• Spend less than 4% to start
• Have the flexibility for variable withdrawals
• Have a more conservative asset allocation when starting out and increase equity exposure later
• Set cash aside to cover X number of months of expected expenses

We've talked before about having a little more cash set aside and kind of related to the asset allocation bullet point, the help that a small percentage in negatively correlated assets can give. A 5% weighting to reliably negatively correlated holdings could grow to 8-9% in the face of a hideous decline. The need to protect against a large decline lessens after a large decline and could be a source of funds in addition to some holdings that are intended to look like horizontal lines that tilt upward no matter what is happening in the world. 

The point is to avoid meaningful sales of assets that have gone down a lot. As the Can I Retire Yet blog said, "all that matters is having enough—enough for me and my needs alone; enough to get me over the finish line" which is a crucial perspective to have in the withdrawal phase. 

I hadn't put this together before but one of my longest tenured clients was 57 and retired when they hired me in 2005. My philosophy was the same back then but there were far fewer tools available. During the summer of 2008, holdings included a gold miner, GLD, an inverse fund, RYMFX and cash to ride it out. This sort of protection is now much easier to add as the fund space has become more sophisticated.

When the financial crisis really kicked in, it was of course an emotional event for the client but I believe it was a great litmus test for the philosophy of cash and low/negatively correlated assets. 

I want to put a different meaning on The Fragile Decade. Fragile decade is a good description for the ten years before you retire too. By your mid-fifties, you probably have some idea of if/when you want to retire, how you'd pay for retirement and have something in mind for taking Social Security. Even if someone that age doesn't have it all dialed in they probably have some sort of framework. 

The fragility in this scenario comes from some event derailing that framework. If at 56, you know at 64 you will have enough to retire and then take Social Security at 67 (so eleven years) there are quite a few different areas of potential derailment. We've talked about several different ones including job loss having to do with something at the company, some sort of health or injury that prevents working, some sort of enormous, unexpected, ongoing expense like care for an aging parent and there must be others. 

In this scenario with our current 56 year old, what if he loses his job at 57, can't find meaningful income replacement so instead of taking SS at 67, he's now looking at 63. The drop in benefit paid for my numbers from 67 down to 63 would be $1049 less per month. Even if it's not precisely linear from person to person, the percentage drop is probably close and that could be a meaningful amount. 

What if layered on top of the job loss, when he's 58 the stock market embarks on 30 month bear market like the popping of the internet bubble and then takes quite a few years to get back to its highwater mark and so too does it take quite a few years for the portfolio to get back to its highwater mark? 

The idea is not to plan for some specific adverse outcome but to work on overall resiliency in case something comes out of left field. This would be a spot to misuse the term antifragile. An adverse outcome doesn't have to leave us better off, just that we stay close to "all that matters is having enough—enough for me and my needs alone; enough to get me over the finish line."

A weird adverse outcome maybe, for an acquaintance who has been making a ton of money for the last few years, 37% federal tax bracket money. He and his wife, they're my age, had a very rough go of it financially for quite a few years starting in the financial crisis, it took awhile but it worked out with this job. I don't really know what they have in savings or the extent to which they do or do not live below their means other than driving older cars but he is going to lose his job in a buyout. 

He is slated to walk away with $4 million, he said $2.5 million after taxes. I don't know whether there is any flexibility in how the payout is taken to reduce the tax burden like $400,000/yr for ten years maybe. Making up numbers and simplifying things, if they have $1 million put away and add another $2.5 million, the 4% rule says they can take $140,000/yr. Where he might be making $800,000-$900,000/yr, if they are living a $350,000 lifestyle, $140,000 doesn't sound so great. There's a lot I don't know which is fine, the thing to take away is something that seems like a great outcome may not be.

My thoughts have long focused on taking the long path to cultivating income streams. I write about this all the time because it seems like the easiest path. There needs to be a willingness in the cultivation process to do things for free and one piece of advice I got a while back is be willing in certain circumstances to do things that other people don't want to do. Another way to describe what I mean is paying your dues. 

The fire department is an example for me. For whatever reason, from the moment I walked in the door I was very motivated to be part of the solution, part of making it better. This was before I understood about it leading to being a lucrative side-gig if I ever needed it. 

Retirement is a word problem like a train leave Baltimore at 5:30.... and it is up to us to figure out how to solve it. 

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.

Navigating The Liquid Alternative "Terrordome"

Jeff Ptak had an interesting writeup at Morningstar about the number of failed liquid alternative funds as measured by how many of them close. 

He says that of the 1,345 alternative mutual funds that existed on Jan 1, 2015, only 341 still trade today. So 75% failed. 

The point is worth digging into but the article seems to go back and forth between liquid alts and alts that are not liquid which is a whole different thing. 

Part of the story with the closure of so many liquid alternative funds stems from some strategy doing very well causing a surge in demand leading to a bunch of new funds. Then maybe the strategy in question struggles, investor interest wanes, leading to some of the marginal funds, marginal in terms of size, to close. My hunch is what I just described is the exact arc for managed futures. There have been a lot of new funds come out and the space has struggled for years in the past. We may be in the early innings of a multiyear struggle.

The conversation here for years has focused on having the wrong expectations for what specific alts will do and having the wrong portfolio sizing. I tell this story all the time but 20 years ago we talked on the blog about what terrible advice putting 20% into REITs and MLPs was and then sure enough they did not help in the Financial Crisis. The reason was simple to understand ahead of time, in times of turmoil the correlations to equities of those two niches tends to go up. Own REITs and MLPs if you want, just don't count on them to go up in a crisis. Both dropped a lot in the early April panic.

Lately there had been chatter about 20% into managed futures. Again, terrible advice. I don't think there are too many people saying this anymore compared to a couple of years ago though. Managed futures are a fantastic tool but a fantastic tool used incorrectly is going to become a problem. We'll see of course but to the premise of Jeff's article, I would expect to see attrition in the managed futures space.

If you've been reading this blog for a while you probably know I am a big believer in merger arbitrage as an alternative exposure. Client/personal holding the Merger Fund has been around since the early 90's and has over $2 billion in AUM. The other old fund in the space that I am aware has symbol ARBFX, it has been around since 2000 and has $730 million. 

To a point Jeff made, there is no hot sales pitch for merger arb. It's boring! That ought have them lining up. There are other merger arb funds but not a lot of them. I don't think the attributes of merger arb lend themselves to a rush of demand so the risk of closure of a specific fund might come down to whether there are enough demand dollars to keep ten of them (not sure the number and Copilot had the wrong answer) in business? The answer might be no but if it is no, I am not worried about the 30+ year old fund with $2 billion being the one to close. 

We look at the Absolute Convertible Arbitrage Fund (ARBIX) for blogging purposes but I don't use it for clients. I think this is the only pure convertible arb fund (if you know any others please leave a comment). ADAIX from AQR includes it but that one also has merger arb and event driven. ARBIX has over $1 billion but the fund isn't that old. If it really is a category of one and it has that much AUM, it's not likely to close.

Is risk parity an alternative strategy? There are just four or five funds. Wealthfront had a large one and it closed, presumably due to poor performance. The RPAR ETF has just over $500 million but has done poorly since inception. Invesco has ABRZX which has similarly poor results. Somehow this fund has $900 million in it and has been around for 16 years. AQRIX is an AQR fund that used to have 'risk parity' in the name, it changed its name but is still risk parityish. It has done better than the others but lagged VBAIX but with similar drawdowns to VBAIX along the way. 

Three years ago, Fidelity launched Risk Parity with FAPYX. It still only has $11 million in it. A Fidelity fund with $11 million? They can afford to keep it open but if Fidelity can't raise assets in a strategy, there are no more dollars out there looking for risk parity. 

I don't think this strategy solves anyone's problem and is vulnerable to closure. Even if you disagree with that, there are other alternative niches that where that description applies.

We've looked a couple of times at the Simplify Multi-QIS Alternative ETF (QIS). Read what QIS is. It's interesting. And very complex. The ETF has $58 million and it "seeks to provide positive absolute returns and income by investing in a diversified portfolio of quantitative strategies chosen to offer an uncorrelated positive source of returns."

No. I don't see how this could stay open. It hasn't done what it said it would do, it's tiny and not only doesn't it solve anyone's problem, I'm not even sure what problem it's attempting to solve. 

The point of today's post is to try to frame out what simple clues to look for that a fund might not last beyond low assets. If it doesn't meet the expectation it sets or offer any sort of useful attribute to a portfolio, then odds of closure increase. Jeff talked about faddish funds (my word not his) which is another area that eventually could see attrition. Does anyone buying the 2x Data Dog ETF, seriously, expect to grow old with that one in their portfolio? A lot of levered funds are likely to die off at some point. What about the 10th to market S&P 500 covered call ETF? 20 years ago, there were a ton of covered call closed end funds, most of them are gone. A repeat with some of the ETFs seems like a good bet.

One thing we do here is to try to sift through a lot of product trying to find the few that reliably do what they say with a strategy that reasonably meets a need. 

I'll close out with a quick word about the Cliffwater Corporate Lending Interval Fund (CCLFX). The prompt is an interview that Morningstar did with Phil Huber from Cliffwater. 

I don't know what to make of Cliffwater's results. Taken at face value, the results are phenomenal. Is the story about how they (don't) mark to market? I don't know. I can't see myself being interested in buying something that is illiquid but the other two portfolios in that backtest, get more than 90% of the return with very little volatility and no gating of funds. Where there are two ways to get close to what Cliffwater has done, there must be other ways too. 

Tip of the hat to Eric Balchunas for the word "Terrordome." 

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.