Analytical Misfire

Barron's had a promisingly titled article Volatility Is Back in the Stock Market. Here’s the Zen Way to Handle It but unfortunately it was very thin. 

Here's advice from Christine Benz

Take the annual amount you’ll need to withdraw from your portfolio in retirement, multiply it by 10, and keep that amount in short-term and intermediate term high-quality bonds. Having 10 years’ worth of living expenses insulated from market movements provides peace of mind.

I don't think I've ever heard ten years worth of expenses hiding out in fixed income but ok, whatever helps someone avoid panic. I'd be more in the two-three year timeframe. Even stranger was the suggestion of using DFA Core Fixed Income ETF (DFCF) which is similar to iShares Aggregate Bond ETF (AGG). DFCF does appear to be a better mousetrap but...

...if the idea is to avoid the ups and downs of markets, why would someone want that sort of duration. Not good. 

The ETF IQ weekly letter tried to explore whether current events in the credit market related to Tricolor and First Brands might mean trouble for ETFs. It isolated the iShares Floating Rate Loan Active ETF (BRLN). It said that BRLN "has climbed nearly 30% on a total return basis over the past three years" compared to just a 16% gain for AGG implying that BRLN might be over extended. 

The 30% cumulative total return cited by Bloomberg has been all yield. If the market that BRLN has been paying 4% instead of 8% +/- then the cumulative total return would have been more like 15%. Credit more broadly could certainly be hitting some sort of snag but the analysis done in this article won't be a contributing factor. 

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.

30 Different Alts?

Jeff Malec from RCM hosted Jason Buck on a podcast to recap the recent ReturnStacked symposium that happened on October 8 in Chicago. One little funny thing before getting to the real content is that Jeff and Jason referred to them as the ReturnStacked guys which is how we refer to them.

Return stacking is a phrase they came up with to describe an older concept known as portable alpha. Thought leaders now view the way to implement it is to leverage up to add uncorrelated alternatives in pursuit of better risk adjusted returns. In decades past, portable alpha often meant just leveraging up equity exposure which went very badly during large declines. The idea of using leverage to add alternatives, they say, reduces tracking error and can help smooth out the ride. 

If you've been reading this site you might recall that I am fascinated by the concept but not a fan of the funds. 

The part of the podcast that was most interesting was their review of the presentation given by Roxton McNeal from Simplify. If you have the chance to ever hear him speak, it's time well spent. 

One of the terms relevant to ReturnStacking/portable alpha is capital efficiency. Being able to build a full 60/40 portfolio (or whatever percentages) with less than 100% of the portfolio so that uncorrelated return streams can be added is the simplest expression of capital efficiency but it is not the only expression.

Roxton talked about being able to get more diversification bang for the buck by using more volatile alts. A portfolio needs to invest less into a managed futures program that targets a 20 vol than a 10 vol. The 20 vol version will be tough to hold, it is twice as volatile, but more efficient.

The way we've looked at this concept is having some alt exposure to something like BTAL or tail risk funds which are more volatile and some exposure to unvolatile alts like merger arbitrage. I would say most, but not all, managed futures funds fall in between those two extremes. 

Also in terms of efficiency, we've looked at using BTAL to allow for having more exposure to equities which gives the opportunity for better returns but without increasing volatility. BTAL is pretty reliably negatively correlated to equities. 

The other point that Jeff and Jason hit on was Roxton's belief (paraphrasing them) that you can never have too much in uncorrelated alts. Roxton even used the word orthogonal which we use here every so often. I would say you absolutely can have too much in uncorrelated alts. Equities are the thing that goes up the most, most of the time. A portfolio of alts, hedged with a little bit of equity exposure doesn't have much chance of capturing the stock market's long term growth. 

If someone wanted 15% in alts and wanted to divvy that up into 30 different strategies (and they could manage that), fine, but the implication there is they'd still have something close to a normal allocation to equities while having a smaller sleeve, the alts, that hopefully makes the portfolio more resilient and robust to market calamities. 

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.

ETFs That Might Burn Down Entire Towns

I saw the following on Twitter.

Here's a chart looking at plain Bitcoin, those two covered call ETFs and the recent one that launched from Tuttle.

Sure, covered call ETFs could help soften the downside in a longer timeframe as distributions come in but sparing any anguish caused by a fast decline it is not an expectation I would have going in.

Did you see this filing?

That's right, 5x leverage on several individual stocks and cryptocurrencies. The more volatile the underlying with 2x, the more the volatility drag impacts return but there isn't a whole lot of predictability or reliability on how the volatility drag will effect returns but it's better to assume the effect will be negative for fund holders. All the moreso with 3x funds and 5x, man, who knows what those will do?

If you're wondering how these could possibly see the light of day, as Dave Nadig points out, there is a quirk in the filing process where these might be an attempt to take advantage of the government shutdown. 

Thanks to the ETF Rule (6c11) and recent generic listing standards, as crazy as these filings may seem, they are actually "normal," and thus, if the SEC doesn't explicitly kaibash them, they go live in 75 days.

Crazy. I make the same joke about ETFs that will melt your laptop, I think the 5x might burn down entire towns. It's not for me to paternalistically say these shouldn't be allowed to trade but if they ever see the light of day, it is a guarantee that people will misuse them and get rekt. 

Speaking of leverage, the FT isolated an issue that might be impacting some leveraged ETFs, the article hit on Tesla specifically. If you remember the few conversations we had about the night effect, apparently most of Tesla's gains come from gapping up at the start of the day and the FT says that is a complicating factor for the levered funds that have a daily objective/reset. 

The 2x levered S&P 500 seems to avoid many of the obstacles that challenge the entire levered ETP concept but even then, they are not infallible. These really are the underlying plus the volatility of the underlying and there's more than just an element of they're whipping around like an unmanned fire hose. 

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.

Is There Such A Thing As A Tax-Less Portfolio

Let's look at a couple of quick theoretical portfolio ideas. Not sure where this first one came from but it's interesting.

It's quadrant-inspired to some degree with 30% in precious metals, 25% in equities, 40% in very low vol, specialized fixed income and 5% selling volatility. It's been less volatile with smaller drawdowns which is good. You can see periods where it has lagged, then caught up and recently pulled away. In 2022 it outperformed by about 11 percentage points, going down much less. 

I asked Copilot to back test the idea from 2010-2020. I used client/personal holding Merger Fund instead of cat bonds and I just said selling OTM S&P 500 puts to replicate WTPI.

In the same period, VBAIX compounded at 10.2% with volatility of 10.26% and a max drawdown of 22.77%. I wanted to isolate the 2010's because it wasn't a great time for precious metals returns. 

Something I haven't needed to manage much in my practice is clients with taxable accounts who are in the 37% tax bracket. I've been doing some subadvising for an advisor who most of his clients are taxable accounts in that tax bracket. In trying to think about portfolio construction, of course the conversation includes "what about AGG or BND" which both track the benchmark Aggregate Index.

From inception in 2004 through to year end 2021, so excluding the regime change that started in 2022, AGG's compounded total return was 3.82% and the price only compounded return was 59 basis points per testfol.io. So the vast majority of the return has been from the yield. Yield that is taxed as ordinary income. Thinking this through, the yield, less the taxes, less the rate of price inflation and there's not much left over. I've never used AGG or BND so this is an interesting way to think about them. 

A high income-tax-bracket investor probably should not have a core position in a fund like this. I do want to make one distinction. I am saying a 60/40 portfolio shouldn't put 40% into these. I could see where weaving in a slice of one of them because it creates some sort of desired outcome when blended with other income market exposures is a very different thing. Just because I don't use AGG or BND that way doesn't mean there are ways to do that. 

Someone recently said to me, if you see a problem, it would be nice to offer a solution and the ETF market does have a solution. 

The backtest is short due to the inception date of client holding BOXX. BOXX has no yield (it paid 1/4 of 1% last year in capital gains) and BALT has not paid any distributions. BOXX and BALT are not without their flaws and where there are these two dividend-less funds with very low volatility, there must be others. The yield in the portfolio we hope is more tax efficient comes from the S&P 500. This past summer the Roundhill S&P 500 No Dividend ETF (XDIV) started trading and as you can see by the name it will avoid paying dividends. It's too soon to draw any conclusion about that fund but so far, no catastrophes.

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.

Solving For Y

Think Advisor posted about a 50/30/20 portfolio where the 20% is annuities. The annuity aspect of it doesn't interest me but it's a good prompt to dig a little deeper on an idea we've explored before related to drawdown strategies for a finite period like maybe trying to make a piece of money last until taking Social Security at the desired age or maybe until RMDs start. The RMD angle presumes the IRA in question is the primary account and maybe the drawdown strategy comes out of a smaller taxable account. There could be many other scenarios though where this theory could fit.

LifeX has a suite of funds that tie into the idea of a drawdown strategy. For this post I'm going to use the LifeX 2035 Income Bucket ETF (LDDR) which as the name implies runs for ten years. At this point, I don't know if next year they will come out with a 2036 version or what their future plans are but I would bet there will be more of these regardless of whether they come from LifeX or other providers. 

With a ten year window from LDDR, maybe this person is 60, retired and wants to take Social Security at 70 or maybe they are 65 and hope this piece of money lasts until RMDs at 75.

I chose $400,000 in this smaller, maybe taxable account versus an IRA that is sufficient for whenever it needs to be tapped. If this person can holdout anywhere close to ten years, then the IRA has the opportunity to grow significantly. 

The weightings  used above are just a slight tweak on 50/30/20. There is barely any income these days from the S&P 500, just over 1%. Client/personal holding EMPIX has paid $0.62 so far this year. As of Jan 6 which is the start date for LDDR, $120,000's worth of EMPIX would have paid a total so far of $7359 which might extrapolate out to $8866. NFLY has paid $6 in distributions so far this year so $20,000's worth at the start of the year would have been 1100 shares good for $6600 of income for the first 10 months of the year. It may not extrapolate this way but for the full year it could be $7951. The $80,000 to LDDR. per the LifeX website, is going to distribute $9373/yr on the way to depleting in 2035. VOO now yields about 1.15% so $2700 there. 

So with this weighting scheme we get the $400,000 paying an income of $28,944 with only 25% in holdings that should be expected to deplete, LDDR and NFLY. If that figure, combined with any other income streams isn't enough, it would probably make sense to take from the 45% we put in equities. 

In terms of trying to plan out what the equities will bring to the table, if over the next ten years the equity exposure compounds at 7%, lower than usual, then whatever amount was allocated to equities (10% or 45% or something else) would have grown in value by 96% total. The scenario might be able to get away with just 30% in equities and put that extra 15% into the yield or depletion sleeves of the portfolio which might add an additional $6000-$7000 of income on top of the $28,944 (less whatever dividends are given up by reducing VOO exposure). 

Sticking with our example, putting the entire $400,000 into LDDR seems unnecessary. We've constructed a plausible scenario that assumes below trend equity growth that could have close to $350,000 remaining in ten years (assumes the 30% in VOO grows to $235,000 and the EMPIX just treads water). And again, the weightings could be tweaked even further of course to increase the income potential.

Yes, it would not be too difficult to do what LDDR does and save the 25 basis point fee and we are assuming LDDR will do what it is supposed to. IRL, 30% in to one specialized income fund is a very bad idea, it would need to be spread out. I would not be afraid of 5% in crazy high yielders though with the expectation and understanding that they are going to erode significantly. That's ok in this scenario. The reason I use NFLY in these posts is it is not the most volatile one in the product line and it avoids crazy CEO risk. 

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.

BDCs Are A Tough Way To Make A Living

Barron's dug in some on business development companies (BDC). BDCs sort of straddle the line between public and private securities. The assets held by BDCs are usually private but the BDC wrapper offers market liquidity, there's no gating or the like as is the case with interval funds or other vehicles. Similar to closed end funds, the market price should be expected to trade at a premium or discount to NAV.

A complicating factor to the pricing though is how the underlying portfolio is marked to market. Like private equity/credit, it's not a daily process. One of the comments on the article (always read the comments) noted that the discount or premium to NAV is the real price, not the marking to market process. There's certainly something to that. There is also leverage involved that, as a generalization, is a little more than the typical leverage used by closed end funds.

Holding on to BDCs is a tough way to make a living, they are volatile. Interestingly or surprisingly, they held up pretty well on Friday as the stock and crypto markets got smacked down pretty good. 

Here's a quick inventory of how they did in 2022.

It's a mixed bag with some pretty big declines mixed in, they got caught up in kind of in a crisis, all correlations go to 1 sort of way.

The biggest attraction to owning BDCs is the yield which tends to be mostly in the 11-13% range with FSK, a KKR product, being singled out in the article as now yielding 19% due to a 34% YTD decline. Down 34%, BDCs are a tough way to make a living. Generally, these are far more volatile than broad equity index funds. 

Above is a comment about BDCs getting hit when correlations go to 1. In 2018's Volmageddon, BDCs held up a little better than equities, in the 2020 Pandemic Crash they got hit harder than equities and you can see above 2022. BDC's do have a vulnerability to volatility events but moreso to credit events. 

Copilot gave me those names as being around in 2008 and still trading today. The hover captures the 2009 low point for drawdowns, very big declines. An analyst quoted several times throughout the Barron's article recommended a newer BDC, Palmer Square Capital BDC (PSBD).

I certainly don't know more than the analyst, he may be 100% right, no idea, but it is easy to observe that this space is a tough way to make living. 

Realistically, the typical investor or advisor is not going to be a position to evaluate the underlying portfolios in these. That doesn't mean the typical investor or advisor can't find and digest how analysts evaluate the underlying portfolios. Ultimately, to buy one of these is to have faith in the manager and be comfortable outsourcing the portfolio construction. Since I can't find another spot to make this point, these are generally very expensive. 

This last chart tries to pull out some of the less volatile BDCs and you can see they've been hit hard. Copilot seems to blame this current decline on slower deal flow and tariff uncertainty. Ehhhh, maybe, not sure. Throwing the S&P 500 in there gives some context for volatility and the TLT comparison shows that whatever is going on, BDCs are not now behaving like long duration assets like they did in 2022. Portfoliovisualizer says that BIZD and TLT have a slight negative correlation. 

IRL, I have no plans to add this kind of volatility into client accounts but this was a worthwhile exploration to try to learn a little more about the space. Off the top, a way to use BDCs in a context we discuss here might be a strategy that tries to barbell a lot of yield out of a 10% slice of the portfolio. Putting 1-2% each into a bunch of different high yielders that might have different fundamental risk factors seems plausible. Even after the absolute carnage of 2008, they eventually recovered.

I would expect bank loans and BDCs to have similar vulnerabilities but the reactions wouldn't have the same magnitude. NLY is a popular mortgage REIT that probably overlaps somewhat on risk factors to BDCs and if you look at a chart, it too has been a very rough ride over the years. I have no plans to add mortgage REITs either.

How does the data look to you on the correlation matrix? Maybe this 10% hell bent for income sleeve can be divided into three groupings. Selling volatility like the derivative income funds which might include the autocallable mania that might be coming, leveraged loans which BDCs can fit into and maybe royalty streams like MLPs or shipping stocks (not really a royalty). Where this is about portfolio theory, there are some ways to diversify/mitigate the consequences of idiosyncratic risks. 

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.

This Post Will Melt Your Laptop

There was a quick mention in the Streetwise column in Barron's about the strong year that the iShares Convertible Bond ETF (ICVT) is having. 

CWB is the SPDR equivalent fund. Clearly, they are both having strong years so this is a good opportunity to reiterate from a few previous posts that convertible bonds, as opposed to convertible arbitrage which is a different strategy than just buying convertible bonds, don't really trade like bonds. Convertible bonds have equity-like volatility. There has been a history of performance differentiation from the S&P 500 which might be interesting but the point is convertible bonds don't really look like what most people expect bonds to look like. If stocks get hit for whatever reason, I would not rely on convertibles to offer real defensive attributes.  

Here's the same grouping from 2022.

In both charts, ICVT and the S&P 500 look pretty similar. Here's the differentiation I was talking about, year by year.

Here are the top issuers in ICVT.

CWB reports by issues held not issuers. 

Although not in the top ten, CWB holds the MicroStrategy converts, other crypto related converts, AI and meme company issues, pretty much just like ICVT. So there is quite a bit of heat under the hood of these funds. That isn't on its face bad by any means. 

While I've been clear I want no part of Strategy, realistically a three-ish percent weighting in a fund that if anything would get a small portfolio weight probably isn't big enough to move the portfolio needle if something terrible happens to Strategy. If the entire crypto space blows up then these funds would probably feel it and if somehow, crypto, memes and AI all got badly damaged at the same time then I would guess ICVT and CWB would both go down a lot. That's not a prediction, it's simply an understanding of the holdings and an attempt to assess the risk. If part of the reason all three (crypto, memes and AI) are doing well is because of the same excesses and then there is a consequence for that excess then all three would probably go down a lot, impacting ICVT and CWB. I'm really hitting on this point not as a prediction but a risk study.

We've looked at the Calamos Autocallable Income ETF (CAIE) a couple of times since it listed. It's a complex product with a high yield that was expected to be a little more volatile than the S&P 500 which is its reference security. 

It seems to be doing what it said it would in terms of volatility including a 3.21% decline on Friday. It has paid out $1 in distributions (ROC) since it listed on its way to what they say should be a 14% annual "yield." You can click above to get a little more detail but part of the story here is that bad things happen to CAIE if the S&P 500 hits a 40% decline/barrier. Obviously that is a very rare thing but in terms of framing one of the risks, that is one to learn about. 

Autocallables are an institutional strategy that is usually wrapped in structured products so CAIE is an attempt to democratize access. GraniteShares filed to issue autocallable ETFs for 20 individual stocks.

There's a lot of heat on that list, I will not be responsible if your laptop melts from looking at that image for too long. GraniteShares of course has a lot of derivative income funds including the YieldBOOST suite which sells puts on 2x levered ETFs. Some sort of comparison between covered call funds and autocallable funds will be a fun exercise if we ever get the chance. Here's the filing. 

At this point, I think that the performance of the underlying reference security is more of a determining factor for autocallables than products like YieldMax covered call funds and I think the manner is which the two harness/exploit volatility is a little different as well which if correct could be a useful point of differentiation for someone managing a drawdown portfolio and is hell bent for yield.

That's just an impression, it is way too early to know whether that is correct or not. 

We got back safe and sound from Maui early Friday just ahead of what might be the start of the air traffic controller callout impacting the Phoenix airport. I don't know what the reality or magnitude of the callout is but if the story is real, then we got lucky. I've been taking pictures of this same truck for ten years. My wife asked if we were going to visit "your truck."

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 Debasement Trade

There's been a lot of buzz about a report from JP Morgan talking favorably about Bitcoin and gold, they are benefitting from a "debasement trade." In reaction to that report, Astoria Investment Advisors wrote an article to spotlight their Real Assets Strategy separately managed account (SMA). They did not spell out the holdings or weightings but did hit on the market segments included.

• Gold
• Bitcoin
• Infrastructure 
• Data centers and digital infrastructure
• Utilities/Power stocks
• Industrials

The idea can mimicked only to a point. I doubt the strategy equalweights the six segments so I'll take a little free rein. 

Something like BTCFX is better for back testing Bitcoin because it has a longer track record than the ETFs. DTCR has "data centers and digital infrastructure" in its name so that seems like a reasonable ETF choice for that segment. Robotics and defense were suggestions from Copilot. XAR is a new one for me, I did not include utilities and I have long thought of publicly traded exchanges as being financial infrastructure which I think fits the theme. 

Four years is a decent amount of time and the results look pretty good but something is missing. There isn't a lot of differentiation. Would you expect a real asset strategy to have some defensive attributes in market drawdown? There have been three drawdowns, two in 2022 and one this year, and it was noticeably better in one of the three. Maybe that is the wrong expectation though?

Chances are this exercise isn't doing Astoria's SMA any justice but whatever is in their model, odds are pretty good that a diversified portfolio that goes narrower than a broad based index fund has holdings that get the "real asset" effect. Things like gold, materials and certain industrials like defense are ripping right now and they are part of Astoria's mix. 

ReturnStacked held a portable alpha symposium in Chicago that of course was in support of their version of it through their suite of ETFs. One of the many Tweets throughout the day highlighted a paper by Michael Crook titled "Portable Alpha for the (Taxable) Masses: Can Capital Efficient Funds Live Up to the Hype?" Gemini provided the following highlights from the paper;

Challenges and Considerations for the "Taxable Masses"

• Consistent Alpha Generation: 

  The core challenge is the ability of managers to consistently generate true alpha, which has become harder in recent years, especially after fees. 
• Costs and Leverage: 

  Portable alpha strategies can introduce increased risk and costs, as well as the potential for misuse of leverage, which needs careful management. 
• Complexity and Risk: 

  Investors must understand the inherent risks of the strategy, including the complexities of maintaining liquidity, meeting cash flows, and rigorous risk management. 
• Manager Selection: 

  The success of portable alpha strategies relies heavily on selecting a skilled and experienced investment manager capable of navigating the complexities of the strategy, according to PIMCO. 

Can They Live Up to the Hype?

• Potential: 

  The hype exists because these funds offer the potential to significantly enhance portfolio returns, particularly when traditional active management struggles to generate meaningful alpha. 
• Caveats: 

  However, this potential comes with significant caveats regarding the sustained ability to generate alpha, the appropriate management of costs, and the inherent risks of leverage and complex strategies. 
• Real-World Application: 

  While the concept is powerful, its practical success for the "taxable masses" depends on the ability of capital-efficient funds to effectively and consistently deliver on the promise of combining alpha and beta in a tax-aware and cost-effective manner, notes a paper on SSRN. 

A point toward the end articulates some of the skepticism I have about the funds. Below is similar to how we have looked at this before. I believe the ReturnStacked guys are comfortable with a 20% allocation to managed futures (I am not). I used DBMF because it uses a replication strategy and so does RSST. I used AGG because based on their other funds they appear comfortable with AGG-like bond exposure

Portfolio 2 is the only one that couldn't be implemented unless someone decided to use margin to build it. Do do that.

Portfolio 1, the one with 20% in RSST, has the lowest CAGR, second highest volatility, largest drawdown, the lowest Calmar Ratio and the lowest Sharpe Ratio. This sort of comparative result repeats every time we look. I think it can be a valid strategy but haven't seen compelling results for RSST versus building it yourself. One fund would be easier but anyone who even knows what portable alpha is can probably handle adding one more fund or two to implement the strategy. I thought that Calmar needs three years of data so the number may not be correct. 

I should probably reframe this a little. It's not that the nominal performance is so bad, other than one fund, but that the additional complexity doesn't appear to compensate fund holders. Look at their latest performance report and maybe you draw a different conclusion.

We are flying back from Maui tonight. 

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.

Deconstructing High Yield

The Absolute Convertible Arbitrage Fund (ARBIX) compares itself to the index underlying the iShares iBoxx High Yield Corporate Bond ETF (HYG). These tables are in their latest email update.

Testfol.io has the following numbers for five years.

I wouldn't be too concerned about the different numbers because they both paint a very similar picture. The returns have been similar but ARBIX gets there with much less volatility. 

Sizing alts correctly is a big topic around here. I suspect my weighting to high yield is lower than normal so I asked Copilot and Claude what a typical allocation is in a 60/40 portfolio and they said 12.5-25% of the fixed income portion (so topping out at 10% overall) and 5-15% respectively. I'm more inline with Claude's numbers. ARBIX is not in my ownership universe but 10% of the overall portfolio would be too much for me but 5% would be fine.

Reducing volatility where it can be done is something I am always interested in. That is not ideal for certain equity sectors like tech, discretionary and some others but makes sense in fixed income or strategies that are fixed income substitutes. ARBIX has no yield so it is a fixed income substitute which has its pros and cons. 

Adding a 50/50 mix with portfolio 3 has an interesting result. If someone was 10% allocated HYG, having 5% in each has done a little better than the two funds individually. 

Bonus topic!

The other day we looked at the Lazard Global Listed Infrastructure Portfolio (GLIFX). The fund has a good track record and a 5 Star rating. I wrote the post because I got a marketing email from Lazard which nudged me to check out the fund. Maybe the reason the email was pushed out was because Lazard came out with an ETF version a couple of days later. I don't believe it is a conversion but the managers are the same and it appears to seek out a low volatility outcome like GLIFX. The fund is the Lazard Listed Infrastructure ETF (GLIX). Please leave a comment if I have wrong about this being share conversion or different class of the same fund.

Rob Forsyth from Lazard was on ETF IQ on Monday to talk about several things including GLIX. Eric Balchunas noted that the Global X Infrastructure ETF (PAVE) has become the largest thematic ETF, probably because it has compounded at 26.5% for the last five years per Bloomberg's data. PAVE has been a client holding since early 2021 and it is up a lot. 

Infrastructure can go in a couple different directions in terms of sector composition. One way is to lean into utilities. iShares Global Infrastructure ETF (IGF) currently has 40% in utilities as it's largest sector. The other way it can go is more cyclical with industrials and materials stocks. A fund that goes heavier into utilities is going to have less equity beta and a lower standard deviation than a fund that is heavy in industrials and materials. 

PAVE has a higher growth rate because it should have a higher growth rate. I bought it believing it could outperform the broad market based on its sector makeup which it has done in six of nine full and partial years of trading. The tradeoff is to realize the drawdowns will probably be larger, including a 44% decline in the 2020 Covid Crash, which has been the case except for 2022 which I think of as being anomalous.  

Having the correct expectations for what a holding will do is crucial for portfolio success. Buying PAVE because you expected it to have defensive attributes like GLIFX would have been disappointing over and over. PAVE was down 25% in the April panic. 

The success of buying PAVE has not been the performance, it has been in understanding what the fund should do.

I threw SPDR Utility Sector ETF (XLU) into the chart because GLIFX and IGF are utility-ish but XLU's performance has been skewed for many years by the strong results from client holding NextEra Energy (NEE) which currently has an 11.5% weighting in XLU and has compounded at 13.9% in the period studied. Any time you see a study from the last 20 years that relies on utilities, assume it is favorably skewed by past results from NEE until proven otherwise. 

There was a fund that came out in the early 2010 that equal weighted the ten S&P 500 sectors (there were only ten back then) and the backtest looked fantastic. Utilities via XLU had a 10% weight in the fund versus a 3% weight in the S&P 500. It probably is not correct to say that NEE alone was the source of the glorious backtested returns but I bet it did a lot of the heavy lifting. 

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.

How To Get Ahead Of Market Calamities

A couple of weeks ago, Oracle was up 36% in one day on cloud news. This week, AMD jumped 24% on an AI supply deal. Oracle went public in 1986 and AMD went public in 1983. Can you recall any instances of companies that mature going up that much on news that wasn't related to being taken over? 

The chart from Bespoke Investment Group shows the semiconductor index about 30% above its 200 day moving average (DMA). Bespoke made a point of noting how quickly the index swung from 25% below its 200 DMA to 25% above and now 30% above. 

Those sorts of numbers for the S&P 500 would be a reason to get more defensive right now. Currently the S&P 500 is about 11% above its 200 DMA which doesn't trigger this indicator. Semiconductor stocks have about a 12% weighting in the index which is pretty big for an industry. The NASDAQ as a proxy for tech is about 15% above its 200 DMA which is not cheap.

If you do a lot of reading, you've seen pundits trying to speculate whether there is some sort of bubble building currently. If there is a bubble, I don't think it is like 2000. Back then, not only was there a flood of profitless IPOs, there were also revenueless IPOs. A bubble now, if there is one which I do not know, would seem to be more about there being a lot of capital available to speculate on a lot of different things with a heavy interest in things related to AI. The massive flows into all the 2X leveraged single stock ETFs are another hotspot for speculation.

Trying to think that through, should the consequences of my description, if it is even correct, be worse than 2000 or not as bad? I don't know. 

In 2008, it was much easier to underweight or avoid the banks without getting left too far behind the index. That assertion is not hindsight bias. Back then I had no domestic bank exposure going into late 2007 and started getting out of foreign banks in 2008. I talked about this on CNBC in March 2008 and there are plenty of posts from me at Seeking Alpha that also document my assertion. 

Clients currently have what I think of as being a heavy weighting to tech which is dominated by all these stocks that may or may not be in a bubble. However, clients have nowhere near the 40% that tech currently weighs in the S&P 500. History has not been kind to sectors that grow to more than 30% of the S&P 500.

I'm not betting client money that I can be as correct (oops, I misspelled the word lucky) as I was in 2008. Trying to completely avoid a calamity that starts in the tech sector is not a realistic expectation and I am not trying to do that. Underweight the sector that gets the worst of it is a good first step to avoiding the full brunt of a large decline. 

If you've read a lot of posts here, you know the importance I place on small exposures to strategies that have some degree of negative correlation to the S&P 500 as well gold. Those are already in place. It would be great to recognize in real time if something calamitous is starting to happen in markets but having taken some steps ahead of time means not having to rely on getting anything else right if some sort of calamitous event occurs.

Managing a portfolio by needing to be correct about predictions over and over is a tough way to make a living. I imagine that makes the endeavor far more stressful. If managing a portfolio is stressful then chances are greater that emotions ramp up and of course it is crucial to long term investing success that we never succumb to emotions in portfolios.

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.

Long Term, Not Tactical

Christine Benz at Morningstar wrote an article advising investors to stop trying to be tactical with the fixed income portion of their portfolios, essentially that most people aren't good at being tactical, and the opportunity costs of being wrong are high. 

Examples of being tactical she cited were trying to assess yield curve dynamics. game the Fed or guess about inflation. There was an implication that these types of trades are done with a very short term focus. Yes, if someone is trying to execute some sort of bond strategy based on what the Fed will do over the next nine months, odds are high that they'll get some part of the trade incorrect. 

Someone going into that trade based on the Fed with a nine month timeframe who then figures they will readjust to the next trade after that, obviously has a very short term focus. That really is a tough way to make a living. 

Forget about tactical though. A 2% yield for a ten year treasury is far riskier than a 6% yield for a ten year treasury. That is not a tactical lens. 2% for ten years will be a very risky position regardless of how long it stays that low. That assessment is about risk. I personally was not willing to take the risk of 2% (and lower) for ten years. I wouldn't take the risk of 5% for ten years. 6%, maybe. At 7%, go on I'm listening. You get the idea. 

With that sort of approach, it is likely you are making longer term decisions. I suppose there could be a some sort of panicked spike in yields that might require a acting quickly to capture the yield. With 7% for ten years, if I can get 60-70% of the return of the stock market for 1/4-1/3 of the volatility (maybe less) in the fixed income sleeve, I am probably interested in that. Buying at 7% and that yield turning out to be a high price on the way to yielding 9% would be far less painful than buying at a 1% yield on the way to 4.5%. To be clear, I am talking about individual treasuries not treasury ETFs.

Where this is very often a longer term proposition, I've been avoiding duration since before the financial crisis, this chart can refute some of Benz' argument about active decisions going bad.

Portfolio 1 is comprised of four fixed income funds, not alternatives, that we use or talk about regularly for blogging purposes, equal weighted 25% each. These funds have been in the conversation here for many years. Unacceptably low yields elsewhere forced me to find other fixed income sectors with adequate yields for risk taken which I did and they work well most of the time. Long term, not tactical. 

Toward the end, Christine talked about whether to use individual bonds. I don't think she was saying not to use them but I would clarify the point. Yields for individual issues will probably be a little lower than in funds but I would definitely include individual issues for a large enough portfolio and someone inclined to spend a little time doing the work. I would not buy $1000 and $2000 bond pieces for corporates, munis might be ok because I often see very small positions offered all the time and buying $1000 into a treasury should be fine.

The bigger point is a diversified fixed income portfolio, if big enough, should include some funds and some individual issues. 

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.

Managed Futures Is So Back!

 Who knows if it's back or not but the last three months have been pretty good for most funds in the niche.

Managed futures can go up when stocks go up but it's not a good expectation to have. After a phenomenal run in 2022 followed by some struggles, it's nice to see it having a positive stretch. All but two of those funds were down in 2024. Coincidentally, all but two also fell in 2023.

Twenty percent into managed futures as a permanent allocation, or higher, is such a bad idea.

Short one 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.

Fly On The Wall

This was interesting;

Corey went on to say that this person proposed replacing a traditional bond allocation with cash which Corey thought was a bad idea. There's a thread if you want to read more. Part of Corey's argument in favor of bonds was increased certainty in terms of yield for a longer time period. I am guessing then he meant actual bonds, not bond funds.

That is an interesting point so I will ask if it resonates with you? Does the certainty of a 4.xx% yield justify the volatility? What about the less reliable correlation between stocks and bonds? The question of correlation comes up in the thread too. 

I've mentioned that some higher level of yield would justify the potential volatility and the now unreliable correlation but that 4% isn't that level and neither is 5% (don't read that as 6% being the answer).

We spend an lot of time here trying to solve the dilemma that I believe a traditional bond allocation poses so you can judge for yourself from previous posts but I am many years in on using most of what we look at here so I believe in the approach of some short term plain vanilla, some bond substitutes and some of the more niche income market sectors. 

The person Corey spoke to asked about T-bills and Corey replied "I'm going to ignore, for a moment, that somehow the same allocators will tell you how timing equity markets is impossible are somehow experts in timing duration." We've talked about this a little too. If the mindset is trying to time the bond market or predict what interest rates will do, yes, that is a losing game. It's not realistic to expect to continuously be correct about what interest rates will do. 

But this doesn't have to be about guessing about anything. It took no great skill or cunning to look at 2% yields, or less, for ten year treasuries from a few years ago and simply decide too risky or not enough compensation or however else you might frame it. It's similar to equities in one respect. If you can buy equities after a 30% decline, there's no way to know whether you're buying at the bottom but buying after a 30% decline will work out very well after a few years (maybe sooner) even if it causes regret a few weeks later. I'd argue that 7% for risk free for ten years is probably worth it even if yields kept going up after touching 7%. That is not a prediction, more like hey, if it ever happens...

And maybe because the following is relevant. Each one has 50% in RISR and 50% in the ETF named in the portfolio. RISR is a hedge with a history of high yields and going up when rates have risen.

If you gots to have bond market duration, there might be a way to neutralize some of the 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.