Is The Scare Over?

On Sunday I wrote a post that could be summed up by saying "I have no idea what will happen next but don't panic." Two trading days later and I can proudly say I still have no idea what will happen but panic is still not the answer. 

I've been repeating the exact same message in various places since long before the Financial Crisis. Things seem like they are different, and of course the details are, but the market reaction does not change. There might be a decline that might last a long time and go down pretty far but whatever the case, that decline will end and then the market will start to work back higher, eventually making a new high.

Without trying to predict anything, I would mentally be prepared for more worry or panic in markets as it sorts out whatever is going on with tariff threats or reality. A crucial point of understanding for navigating any sort of adverse market event regardless of whether there is visibility for it or if it comes out of left field is to have the proper asset allocation for your circumstance.

Are you 40, have a little bit in an emergency fund, a long time until you retire, no near term large purchases coming and a job you like? Then it really doesn't matter at all what the stock market does over the next little bit. 

Are you 63, on the verge of retiring, have enough for your plan to work and done something to mitigate sequence of return risk (like setting aside 18 months of expenses in cash)? Then it really doesn't matter at all what the stock market does over the next little bit. 

Are you 56 and a little behind where you think you need to be but still putting money away every paycheck? A decline actually helps you by buying at lower prices for a stretch. 

Are you...ok, you get where I am going with this. 

Having all of these ducks lined up makes it much easier to navigate through whatever it is we might be going through right now. If Monday's open left you feeling like you have too much in equities, at Tuesday's closing level the S&P 500 is less than 2% below it's all time high. Selling some, 2% from the high is not selling after a large decline which is a terrible thing to do. 

My comment is not about guessing what the market will do, if the scare Sunday night into the open on Monday's left you thinking you have too much allocated to equities then selling a little now, while the market is still high might be the difference maker to avoid selling after the next large decline.

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.

Bracing For A Big Monday

I'm writing this post mid-day Sunday before the futures open. Bitcoin is the only thing that gives any indication of the reaction to the tariff news or just threats, who knows but at a minimum, the tariff news is dominating the conversation this weekend.

It seems like markets will react swiftly and negatively, great if that turns out to be wrong. I certainly don't know what will happen in terms of a reaction. Maybe it will be very serious or not so serious I don't know. Whatever is coming, what we do know is that at some point the reaction to whatever the reality will be is going to end and then after that the market will start to work its way higher. The only variable is how long that takes to play out. 

If you've been a market participant for a while, you've been through plenty of market events that were each "different" except they are not different for the reason I just said. The market might go down but at some point the decline ends and then it starts working back to a new high. The only variable is how long that all takes. 

For a little context, if the S&P 500 were to fall as much as 5% on Monday, down to 5700, that would be a level first reached last September. When the S&P 500 first reached that level, it was up 20% for the year at that point and everyone felt great about stocks. 

The point here is not to sugar coat anything but more like if this is bad (maybe it won't, I don't know, repeated for emphasis) to realize there have been plenty of bad or scary events in markets before and at some point they end and after that a new high comes. 

A Core Alternative?

A couple of interesting points today related to fund categories that we talk about here all the time. First up is that Locorr just launched a fund that combines US equities and managed futures 50/50, the Locorr Strategic Allocation Fund (LSAIX). Also, TIL Locorr is a play on words, low correlation. The fund just started trading a day or two ago but the results of funds that do this combo have been pretty good for the most part. The fund we talk about the most is client/personal holding Standpoint MultiAsset Fund (BLNDX) which differentiates with global equities and a very low volatility target. 

AQR changed one of its funds from carbon aware fund to combine domestic equities and managed futures. The Abbey Capital Multi-Asset Fund (MAFIX) and the Catalyst Millburn Hedge Strategy Fund (MBXIX) both do something similar (MBXIX has a little more going on under the hood). I found out about LSAIX from a Tweet by Corey Hoffstein who speculated that Man AHL and Alpha Simplex will also soon launch funds into this niche too. 

We talk all the time about how difficult it can be to hold a managed futures-only fund. There can be long periods where the strategy appears to languish. I would argue it's doing what it is supposed to do which is have a low correlation to equities. If stocks are up a lot then I would not expect managed futures to also go up a lot. It could happen, but I would not expect it. The benefits of managed futures typically occur when something bad is happening in the equity market. It helps as what we've been referring to as a second responder. 

The combining of equities and managed futures in the manner that these funds do typically has the effect of smoothing out the ride, of lowering volatility, less though with MBXIX. Looking at the three I mentioned versus 60/40 proxy, VBAIX, you can see that the difficulty of holding managed futures during bull markets mostly disappears. 

And the year by year

MBXIX is curious. It had a couple of terrible years this decade but was the best performer in 2022. Certainly 2023 was tough for these funds but while managed futures didn't do very well in 2024, the funds generally kept up with VBAIX. 

I've told the story 100 times about Standpoint making contact with me a couple of months before the fund launched (I was not special, I simply responded because the idea immediately resonated). This type of fund might be as close to building a core position around an alt as I would be comfortable doing. The risk clearly is that in a year like 2022, managed futures "don't work" while equities are going down a lot but what I know of managed futures and studied, large drawdowns for managed futures haven't been anywhere near as big as large drawdowns for equities. Is that enough comfort for you? I don't know if it is enough for me but if it isn't enough for you then don't build a core position in a fund like this.

A quick note about the ReturnStacked US Stocks & Managed Futures ETF (RSST). That fund is part of this discussion too but it has 100% equities which gives it a higher volatility than the other funds in the short time since it listed. 

And the other fund category to look at today is merger arbitrage which Barron's wrote about as a possible bond substitute. Ok, we've been making this point since the early days of the Obama administration but it's nice to see the idea getting more traction. Barron's believes that the new administration will be friendlier to certain types of mergers than the previous administration. 

The idea makes sense but we'll see what the reality is. If the Biden era was not favorable for mergers, ok but the funds still acted the way I would expect which is as a horizontal line that tilts upward in a manner that I think most people hope bonds will behave. 

One comment, always read the comments, did not see the appeal and two others replied in agreement. It seemed like he didn't understand the bond substitute point being made. The function it can play is to bring down a portfolio's overall volatility without the risk associated with fixed income duration. In 2022, the Merger Fund which I own personally and for clients was up 71 basis points. As for some others, ARBFX was down 1.02% in 2022, MNA was down 1.61%, VARBX was up 2.38% and HMEZX was up 2.7%. 

I wouldn't build a portfolio with 60% equity and 40% merger arb because nothing is infallible but obviously I have been a big believer for a very long time. 

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.

"Trinity And Chill"

Meb Faber hosted well know trend following manager Jerry Parker for a podcast. The two partner on Cambria Chesapeake Pure Trend ETF (MFUT). Parker also manages the Blueprint Chesapeake Multi-Asset Trend ETF (TFPN). They've done at least one other podcast together and I wrote about that one too so just a couple of points to make today.

Yes, there is plenty of history to support the idea that managed futures is pretty reliable when it comes to functioning as crisis alpha. Pretty reliable doesn't mean infallible, there could of course be some sort of crisis lasting longer than a few days, in the future where it doesn't react like it has previously. Whipsaw environments typically aren't good for managed futures and it seems plausible that whipsaw action could coincide with a stock market crisis. Still though, the track record is excellent and I am big believer in small doses.

A comment that Meb made before and repeated was about having 50% of the Cambria Trinity ETF (TRTY) in trend one way or another which I think includes the momentum factor for equities and managed futures. TRTY is a quadrant sort of permanent portfolio inspired idea. It seems like TRTY is Meb's favorite Cambria fund because of the tag line Trinity and chill but who knows. 

I built out the following, allocating 25% to each holding and compared to VBAIX, PRPFX and TRTY.

The full term backtest of Trinity/Permanent Inspired is compelling of course but it trailed VBAIX and PRPFX in 2020, 2021 and 2023. In 2024 it was slightly behind PRPFX and slightly ahead of VBAIX. It was up in 2022 which contributes mightily to the CAGR being the best of the group. If momentum has a much better year than market cap weighting in a year that MCW does very well, then Trinity/Permanent Inspired might be able to keep up with VBAIX and PRPFX but I wouldn't expect that to happen very often. Also both alts can very easily lag from year to year when stocks are going up which could try investor patience.

It really is important to understand that while the CAGR and other portfolio stats look outstanding over a period of years, the portfolio would likely cause frustration in more years than not. 

Side note, in other blog posts where we've looked at TRTY, this time period which is dictated by QDSIX is the best performance for it that I've ever seen for that fund. The concept is very intriguing but its actual results have not been. 

Another quick fire department story. I mentioned that we recently upgraded our engine for structure fires which left us with an old one to try to sell. As luck would have it, one of the board members found a buyer very quickly. We were storing it at a community member's house since the new truck came. We had a huge snow storm here this week that of course coincided with when it was due to get hauled off to its new home in California. We had a plan, so I thought, where I was going to drive the truck from the community member's residence to the firehouse and the trucking company would get it there.

The snow added some risk but the plow job on the road combined with a relatively gradual hill to drive down and the weight of the truck should have been no problem and fortunately it wasn't! This wasn't riskless but it worked out and I just had to then drive a half mile on the pavement to meet the trucking company. For who knows what reason or where he thought he was going, the driver went sailing passed the firehouse. He got caught then in an intersection that wasn't big enough for him to turn around. It turned into a two hour ordeal where the solution finally was a backhoe came and moved his back end. 

When we finally got the the firehouse, it took him about 20 minutes to get situated but that's ok, I'm off the hook, I got the old engine to the firehouse unscathed. Nope, I had to back it onto the trailer. I think it was kind of a lowboy, where the truck pulls away from the trailer and then you back on which I found out, I had to do. 

Not much margin for error but I got it done. I don't believe I was in danger of getting hurt if something went wrong but could have easily, seriously damaged the truck and cost us quite a bit of money if this went sideways. All good and the truck was on its way.

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 Trip On The Bolivian Death Road

First, a wild chart about Nvidia's market cap. 

Who knows if it will actually catch up the the entire Japanese stock market but that really is something. Historically, this sort of thing tends to be unsustainable but interesting all the same. 

We've talked before about the Alpha Architect 1-3 Month Box ETF (BOXX). The short version is that it replicates T-bill exposure with a four legged SPY option combo. The fund price accretes a penny or two just about every day that annualizes out to equal the yield of a T-bill. The advantage here is that there is no interest paid, you get the interest equivalent in the penny or two every day, so there is no ordinary income tax. There should only be a capital gain (a loss is theoretically possible of course) when you sell. Note there there was a small capital gain distribution from the fund for 2024 but not the other years it has traded. BOXX is a client holding. 

With that as a preamble, in December they launched the Alpha Architect Aggregate Bond ETF (BOXA). In a similar manner to BOXX, BOXA uses an option combo to replicate the benchmark Aggregate Bond Index such that BOXA should pay no dividends, accreting in price ever so slightly to give hopefully the same total return as a fund tracking the Aggregate Index but in a more tax efficient manner. 

Obviously to even consider BOXA, you have to want Aggregate bond exposure which I do not and we'll see if BOXA works as intended but BOXX has. Alpha Architect has filed for several other funds of this nature. For all the options based funds that have come out in the last few years, this little corner of the that space seems to be very productive bit of innovation. 

This chart comes from Torsten Slok and his Daily Spark blog. 

I've never seen a four quadrant portfolio referred to as a Barbell and I've never seen the "Replacement" portfolio anywhere either. Both seem to be Permanent Portfolio inspired. Where Slok works for Apollo I would take anything even tangentially related to private equity or private credit with a grain of salt.

Maybe portfolios at the institutional level, were 25% fixed income and 25% alts going into 2020 but it's difficult to envision retails sized accounts (with an advisor or do-it-yourselfers) having anywhere near 25% in alts even today. 

Finally, a fire department story from last night. On Monday, we had our first real snow storm this winter. It was only a few inches but the driving here can be trickier in the snow than you might intuitively think and only the main roads are plowed.

We got called out for a medical call at 8:30pm to just about the worst road here imaginable. We put snow chains on about half the fleet on Sunday including our ambulance. When the call came in, it was snowing lightly but for the duration of the incident, very heavy snow came and went. We had to drive a long way up a main road that isn't plowed by the county (long story) and then we had to turn off to drive what I think is about 1/3 of a mile on a road that looks like the following. I kid you not. 

The road had been plowed earlier but at this point snow had built back up. The road ends at the patient's house. The ambulance company's vehicle would not make it there, we had them go to our station house, had them hop in our ambulance and off we went with our ambulance and then three of us were in my pickup truck which had all four chained up. 

In addition to the road looking like this, there are a couple of switchback like turns that require a 3-4 point turn to negotiate. Fortunately, we knew there would be no one driving out while we were driving in. 

The ambulance had all the medical personnel that the incident required, so not knowing how much room there would be for multiple vehicles to turn around at the end, I staged in my pickup before the Bolivian Death Road portion started with two other firefighters on standby in case something bad happened on the road to the ambulance or if somehow more people were needed at the house. 

The ambulance made it and I thought I was home free not having to drive that road. Ten minutes later, the incident required that we go to the house which we did. Then the circumstance of the incident required that I go back out not quite all the way, do a task and then go back to the house. I went from not having to drive that road at all to having to do it four times. 

Four wheel drive low, lowest gear on the transmission and snow chains was fortunately pretty bullet proof, nothing hairy happened. 

We get so few calls for service and the temperature is supposed to go way up in a few days so I didn't chain up the department Suburban that we keep at my house. I mean what are the odds that we have to drive on the worst road in partial whiteout conditions?

The Suburban is pretty heavy but I knew the road we were going to so I went with my pickup plus it was better for loading up equipment in case the ambulance had a problem. There are a lot of calls for service that I don't remember but this one will stick with 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.

DeepSeek Deep Sixes Markets

I wanted to follow up on a couple of ideas from recent posts, which I'll do, and then address the market action today. I had this idea last night for an example of how a small slice into a crazy high "yielding" derivative income fund could help with barbelling portfolio yield. I built out the following using names we use as examples all the time, adding a 5% allocation to YieldMax Netflix (NFLY) and compared it to the Vanguard Balanced Index Fund (VBAIX). 

The YieldMax website says NFLY yields 40% and while that number moves around due to lumpiness in the monthly distribution and movement in the price of the fund, taken as a static number, 40% from a 5% holding implies getting 200 basis points of yield out of a pretty small portion of the portfolio. The context the other day was a portfolio looking to generate a 4% withdrawal rate. There's no reasonable, near term threat that Netflix could go out of business (over the very long term, anything goes) but I might expect the common stock to go down more than the broad market whenever the next bear market comes and there is no reason to think NFLY would be spared in that scenario. Splitting the 5% to NFLY with 2.5% into two different crazy high yielders would help diffuse any sort of unforeseeable idiosyncratic risk that one name might have.  

Cutting in half when the S&P drops 35% would not surprise me so that might quantify the risk of decline which differs from whether or not NFLY can keep up with its distribution. So in some sort of bad run for equities broadly, I'm framing out where NFLY's impact could be a negative 250 basis points which would be a bummer but not catastrophic for the overall portfolio.

The portfolio as constructed, yielded 6.25%. Portfoliovisualizer has a mistake with VBAIX' yield for 2024. From Yahoo, VBAIX paid out $1.03 for the year and started 2024 at $43.91 which puts the yield at 2.3%.

Now to today's pukedown in the market. The DeepSeek news could be very big if the first reports are close to being correct. I obviously don't know, and we don't know whether today was the start of something serious or whether it is soon to be forgotten which is exactly what we said about the dip in early August. 

I grabbed this screen shot toward the end of the day.

First, the 2x did exactly what it's supposed to do, almost to the basis point. The challenge in getting capital efficient exposure with half the money into a 2x fund is there is no way to know what the path will be going forward. The sequence returns in the coming days or weeks could result in NVDL doing better than 2x the common, worse than 2x the common or be right in line. 

In 2023, NVDA was up 239% while NVDL was up 431% so the 2x was off by 47 percentage points, not basis points, percentage points. Is that close enough though? In 2024, NVDA was up 171% versus 344% for NVDL so it was only off by two percentage points which I'd say is pretty close. Despite the clear boilerplate about not holding these funds long than one day, plenty of people do. Maybe they shouldn't, but they do. 

NVDY's decline makes sense. For a fast move like today, the income shouldn't be expected to help. Over a longer period the income could help in a total return sense, I say could help but even that is not certain. 

A little more broadly about the market, again I do not know how serious the DeepSeek news will be but today as a microcosm shows the risk of going too heavy into whatever is hot in markets, AI related stocks on this go around. Do you have any sort of defensive positions or hedges? How did they do? The list I track, including what I use for clients were pretty much flat for the ones that should be flat and up for ones that should be up except for managed futures which were down varying amounts. Gold too was beat up a little bit.  

If you use defensives and you don't have 20% in managed futures (I think 20% is too much) then hopefully you were down less than the broad market. If you were down less, then that is the payoff for allocating a small slice to holdings that might cause frustration when things are going well. 

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 Dalio

Ray Dalio was interviewed by a couple of outlets while in Davos including by Yahoo Finance. The article was thin but there was a reference to his "holy grail" of 10-15 uncorrelated assets in portfolio construction. I haven't seen any articles/interviews where he shares idea on what should make up the uncorrelated bucket and how much to put into the uncorrelated bucket so if you've seen anything along those lines please leave a comment. 

We've looked at this a couple of times, it is interesting of course and actually having 10-15 uncorrelated assets in a portfolio would hit the mark for diversifying your diversifiers. Where equities are still the thing that goes up the most, most of the time, any exercise along these lines should have some sort of normal allocation to equities, for this post we'll look at 50% equities and 60%. 

Finding a bunch, even if not the full 15, of assets that have historically been uncorrelated wasn't that hard. Here's a dozen of them

I didn't include a straight inverse fund but client/personal holding BTAL does something very similar as does VIXM. With a couple of exceptions, most of them have no correlation to each other, not just that they are uncorrelated to stocks, which is what Dalio has in mind. Solana and Bitcoin have had a low correlation to each other but the extent to which they are correlated to stocks changes frequently. 

AMPD which I mentioned recently and am still not sure what it does is a very new fund which shortens up the backtest considerably. There are some interesting things though in the month to month data of the backtest, so I will start with that.

There are pockets of differentiation here and there. I highlighted three very big up months that were driven by the allocation to asymmetry, Bitcoin and Solana. The larger weighting to those two than we normally talk about but there were instances whether that worked against the portfolio too. The first month in the table, both portfolios lagged due a drop in Solana.

Where we talk often about the difficulty of holding managed futures, take a look at the rest of the table, the month by month of each holding.

There are a lot of red months for the alt funds. Stocks go up most of the time so if something has a negative correlation to the thing that goes up most of the time, then it, the alt, might go down most of the time. It can be difficult to sit with things that go down for an extended period.

I shortened the performance to last May to take out any huge gains from the crypto holdings.

The performance going back to June, 2023 has the two Dalio portfolios outperforming by a mile along with higher standard deviation. This shorter period though looks similar to VBAIX but avoids any sort of interest rate risk. Isolating the returns of the diversifiers in 2022, but taking out OSOL and AMPD because they weren't around the whole year, you can see that only Bitcoin had a rough time, several were flat (which is good for a year like 2022) and several were up a lot. 

I believe in most of these having a reasonable chance to up in a bear market for equities. Crypto, you never know and I already said I don't understand AMPD but the others I am confident can help more often than not realizing nothing will work every time. 

The Dalio idea is certainly valid but do you think you need that many uncorrelated assets to make it work? Not holdings necessarily but assets that are uncorrelated? There are some diversifiers that I would not want to put 10% in, like BTAL, but something like TFLO (I own a different one that does almost the same thing) would not be problematic. The history of catastrophe bonds suggests 10% is fine but I wouldn't go that high. In certain instances, client/personal holding MERIX would be fine at 10%. 

I'd bet seven or eight would get it done but I would think of asymmetry (Bitcoin/Solana in today's post) as being it's own sleeve. The big idea for me is taking Dalio's concept and seeing if it helps better manage the 40 that usually goes to bonds in the typical 60/40 portfolio. I think it does help, I've probably been doing a version of this for many many years but with fewer uncorrelated holdings. 

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.

High Volatility!

We have a lot of ground to cover today involving volatility and portfolio construction. The starting point is a podcast featuring Jeff Park from Bitwise. Jeff has some interesting takes on some topics but there is also a fair bit of sifting required to get to the good stuff. Where the utility came in was taking a second order effect from what he was saying. 

Keeping in mind who he works for he had some interesting things to say about meme coins, aka shit coins that on the surface appear to be nothing but devices for gambling. He didn't make the case that meme coins are somehow not just about gambling but that there is a way to have an information advantage as a function of time spent understanding various types of technology. He equated the manner in which some people play this market as being more about skill akin to poker, than gambling that requires no skill like slot machines. He acknowledged there are plenty of people just speculating on meme coins with zero understanding.

An information advantage also applies to individual stocks and various private equity and private credit opportunities that are becoming more prevalent. Using Jeff's idea, I assume no information advantage where private equity and private credit is concerned which is why I would urge caution. A small allocation to a vehicle offering private whatever, ok, maybe it works out, maybe not but the consequence for being wrong won't be disastrous. I would just be aware that with some of these pools, someone is going to be the last sucker. 

Another interesting point by Jeff about meme coins is that yes, a lot of them (most of them? all of them?) do go to zero. So too though do many stocks, look up survivor bias, but with meme coins it happens faster. 

Is that already happening with the Melania coin that came out a week ago? I have no idea, I realize I have no information advantage here. The screen shot is from a post on Bluesky. Is Walgreen's on its way to zero? I don't know but it's been on a long slow ride down 85% and plenty of blue chip type stocks have disappeared or are shells of their former selves, Kodak anyone? 

A last point about meme coins that resonated was that trading meme coins can be fun (that's Jeff talking) and so you could think of it as spending money to do something fun. That is very similar to what I've said about buying an expensive collectible or a fraction of an expensive collectible like a baseball card. If you want to throw $1000 toward fractional ownership of very expensive card, go for it, but I would think of it as spending money not investing it. If you get a return, cool, but if you love baseball then owning a small piece of a $980,000 card seems like it would be fun and maybe someone else would get that same enjoyment from some sort meme coin.

A little more broadly, Jeff quickly shared thoughts on constructing 60/40 portfolios drawing a similar conclusion to me about bonds' diversification benefits. I didn't take him to say don't own bonds, more like they no longer offer the diversification benefits they once did. He talked about 60% into more typical holdings (stocks and bonds) and then 40% into truly uncorrelated assets like various forms of crypto and he specifically also mentioned litigation financing. 

Ironically, this review of Nouriel Roubini's new Atlas America ETF (USAF) in Barron's quoted Roubini as saying almost the same thing as Jeff about bonds' diversification benefits. 

The 40% as Jeff seemed to be framing it, took me to thinking about allocating to volatility or as you'll sometimes read about it, as harnessing volatility. This is intriguing to me, all of our conversations here about barbelling volatility seem relevant to this post as crypto and meme coins are about how to introduce volatility into a portfolio in such away that it doesn't cause real damage. Yes, the image I made below sucks but like many different exposures a portfolio could take on, volatility used prudently can help with risk adjusted returns or used imprudently could cause absolute carnage.

Over the last year or so, there's been an onslaught of new ETFs that one way or another provide access to harnessing volatility and, because I think it is related, funds offering access to asymmetry and this year the list of filings and actual new funds seems to be growing at an exponential rate. Check out ETF Hearsay's feed on Twitter to see what I mean. 

Yesterday, there was an avalanche of filings for Ripple, Litecoin and Bitcoin adopters ETFs, leveraged and inverse versions of those funds and even more funds that blend crypto and derivative income. That latter could arguably be both long and short volatility which is an idea we've looked at before. 

There is clearly a mania going on here. With all the dollars involved, it is probably big enough to be a bubble but right or wrong, I am not convinced that the percentage of Americans that own crypto is as high as a Goggle search would tell you. If I'm wrong, I'm wrong. 

I flat out believe that volatility when used correctly can be additive to a portfolio, same with asymmetry but I would be concerned about something bad happening in this volatility space (derivative income funds "yielding" 60%) or as part of the same event, something bad happening with asymmetry as applied to the crypto space or levered, single stock ETFs.

If you would normally put 5% into one stock and instead you put 2.5% into a 2x fund with the rest of that 5% in cash, the daily tracking of that 2x fund may or may not be problematic but you wouldn't be doing yourself in versus putting that entire 5% into a 2x fund, essentially taking on a 10% weighting. The former is leveraging down and the latter is leveraging up.

I wouldn't dismiss all of this out of hand though. If the idea of barbelling asymmetry into a portfolio holds any appeal to you, I do think this is valid, how much would you allocate to asymmetry? If you have $1 million in markets, maybe dialing down the Nassim idea of 10% into very risky holdings, what about 5%? Putting $50,000 into just one risky exposure with asymmetric potential may not be very comfortable but what about $5000-$10,000 each into a handful of ideas? If that makes sense, ok but putting $10,000 each into Bitcoin, XRP and Microstrategy sounds like loading up on the same risk. That's part of the reason why we talk about the importance/benefit about taking the time to learn at least a little about many of these. I don't yet really know anything about XRP but it probably makes sense to dig in at least a little. 

In building an asymmetry sleeve, if you want to go as big as 5-10%, 10% is a no for me but I could be talked into 5%, spread it around with maybe a little in crypto, maybe some in AI (beyond the Mag 7), quantum (dig in and you'll see it's different than AI) a lottery ticket biotech and maybe a hole in the ground with a liar standing over it, oops I mean some sort of unproven mine just as examples. 

We also have talked about barbelling yield which is where selling volatility can come in. There are really a lot of derivative income funds (repeated for emphasis) and I would not go heavy by any means but as an example we've gone over before, an account looking for a 4% withdrawal could get half of that from a 5% allocation to a couple of crazy high yielders, all the better if any of the "yield" is actually return of capital which is sometimes the case. The growth from the rest of the portfolio could offset the price deterioration of the crazy high yielder. This is also a path to nudging up the income taken by a percentage point or so but notice, we are talking a very small allocation in case something goes wrong.

A lot of the derivative income funds have real issues but I think we are moving toward a usable product. I don't know if there is an XRP derivative income fund in the works but if there was, it would be a product that sells XRP's volatility, not a proxy for XRP.

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.

Keep It Simple And Diversify Your Diversifiers

For awhile, I've been seeing that Calamos has a suite of Bitcoin protection ETFs, so like defined outcome or buffered. Where I always say just don't with the buffered ETFs I haven't looked into them at all but the following popped up on my Twitter feed, yes I am still calling it Twitter.

I will take the perspective that most readers are curious but not true believers. If you fall into that camp, that's where I am, then capping the upside makes no sense. If you're a true believer, I'd bet you have more actual Bitcoin than investable brokerage products. At a market cap of $2 trillion +/-, it is nowhere close to big enough to do what the true believers think it will do. 

A 55% gain does nothing toward becoming a solution for anything. A 10x gain from here probably isn't big enough to do everything the touts are calling for. Call me at 20x from current prices. I'm not saying it will happen. I doubt it will and I doubt it will evolve to solve any problems. But it could go much higher while failing to solve all the world's financial problems and I am along for that ride. I'm way up on most of what I own and at $700k-$800k per Bitcoin, that might be lifechanging money for me as I have referred to it before. 

Buy it or don't buy it, I am not here to talk anyone into speculating on this but if you are going to dabble, at least do it for the right reason and the right way and capping the upside is wrong on both counts. 

Writing for ETF.com, Allan Roth tried to get readers to remember what it feels like when equities go down a lot, 40% in his made up scenario. There will obviously be future bear markets and the extent to which they cause real damage to a financial plan depends on whether any steps are taken to mitigate the full brunt of a decline that. It's very simple. Have some number of month's worth of expected expenses in cash or cash proxies and have some of the portfolio allocated to first responder defensive holdings, like BTAL for me, and some of the portfolio in second responder defensives like managed futures. BTAL and managed futures are just examples, they are not the only ones. Bear markets typically last 18-30 months which could serve as a guide for how much cash to set aside. 

Speaking of managed futures, Institutional Investor had an article about using managed futures (MF) as part of a portable alpha strategy pointing to MF as the best tool for portable alpha. There wasn't much that was new but there were some interesting comments toward the end from Razvan Remsing about investors not wanting to allocate too far away from equities for fear of missing out on returns. This makes sense to me as equities are the thing that goes up the most, most of the time. By adding MF on top of equities as the basic argument for portable alpha goes, you don't give up the equity returns of a full allocation, whatever that might be, and you get the diversification benefits of MF.

Yes, equities are the thing that goes up the most, most of the time but it can also be true that managed futures have excellent diversification benefits in the form of crisis alpha. A common allocation for portable alpha implementation (per what I've read) is 30% into some sort of alternative strategy, managed futures for this post, so I played around with it on testfol.io using leverage, versus not using leverage and T-bills versus the more common AGG bond benchmark.

Both unleveraged versions had very smooth rides with a real return, meaningfully above the rate of inflation. In 2022, the two unleveraged versions were down 66 basis points and up 3.56% respectively while the leveraged version fell 6.87%, a great result, while plain VBAIX dropped 16.87%. Both unleveraged versions were down 800-900 basis points less than the others during the 2020 Pandemic crash. 

The history of managed futures zigging when stocks and bonds zag, has been pretty reliable but of course the risk is that in some future event, managed futures also go down a lot. You implement something close to what the II article talks about, heavy into managed futures, back to Roth's article where stocks drop 40%, what if managed futures drop 30% at the same time? It's unlikely but not impossible for some sort of unpredictable, awful coincidence to take them both down together. It would be even worse if leveraged was used to build up the managed futures position. 

We can use the WisdomTree Core Efficient Portfolio (NTSX) to easily model a more modest 5% to managed futures. NTSX is leveraged such that a 67% allocation equals 100% to VBAIX.

The 5% weighting to managed futures helped by 167 basis points in 2022. If managed futures had cut in half, that big of a decline may not be possible but still, then it would have been a 250 basis point drag in this example versus 1500 basis points at a 30% portfolio weighting. 

Keep it simple and diversify your diversifiers. 

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.

Trying To Utilize Leverage

The starting point today is the that Rational ReSolve Adaptive Asset Allocation Fund (RDMIX) has gone through a strategy change, renaming as the ReturnStacked Balanced Allocation & Systematic Macro Fund and keeping the same symbol. "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." 

Per the fund page under the FAQ section the balanced allocation portion will be comprised of 50% iShares S&P 500 (IVV), 25% iShares Aggregate Bond (AGG) and 25% ten year US treasury futures. The macro portion will have exposure to several hedge fund-like strategies including momentum, trend and carry. 

I backtested as follows with Portfolio 3 below being Vanguard Balanced Index Fund (VBAIX).

QSPIX is sort of a cherry pick. I plugged in several different funds in that spot. MBXIX added the best long term result but QSPIX had the best performance in 2022.

The backtest assumes the new RDMIX would be the core holding of a portfolio but I didn't find anywhere that talked about how to position the fund. Going the leveraged route has better returns but more volatility. There's very little difference in the Calmar Ratios between the leveraged and unleveraged versions but both were much better than VBAIX while the kurtosis numbers were far inferior to VBAIX. I was very skeptical of the previous iteration of RDMIX, hopefully this one will be better but anyone interested in buying the new RDMIX has to want that bond exposure to AGG and ten year treasuries. 

Next is an updated chart from Bob Elliott of Unlimited Funds that we've looked at previously.

Coincidentally, I had another tab open, that I accidentally closed, with an article about just owning all of the more typical hedge fund strategies but leveraging up to do so which ties in a little with RDMIX appearing to be multi-strategy and Bob laying out the above strategies. I excluded fixed income and emerging markets.

I built out the following on testfol.io with Portfolio 4 being VBAIX.

MERIX is a client and personal holding. The 50/50 version is the most interesting to me. 

The 50/50 version did far and away the best in 2022. None of them helped though in the 2020 Pandemic Crash.

The leveraged version outperformed going into the 2022 bear market (that started late in 2021) but has had a tough time digging out of that hole since then. It probably will eventually unless the next bear market comes before that happens. 

There's a lot of research that supports using leverage, portable alpha, with assets that should be uncorrelated but it is still difficult for me to see the value in doing so when you consider the risk. The idea of adding alts is about improving risk adjusted returns and unleveraged they do just that in almost every backtest we run and this has been my real world experience too. This post is another example where leveraging up doesn't improve risk adjusted returns when they are needed. 

Do what you think is best but I am not there with meaningful leverage. A 5% weighting in an alt mutual fund that leverages up is a different story. The consequence for the leverage going bad in that instance would be small.

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.

Cash vs Bonds

Barron's looked at the merits of holding cash versus bonds which fits in here very well. The article was fine for the most part. It generally tilted toward cash between the two, until the end when it quoted an investment advisor who started to extend duration a year ago, unfortunate timing. 

"But Elser isn’t swayed from her belief that bonds make more sense than cash over the long run. She notes that bonds have outperformed cash over much of the past 20 years." Um, insert the googly eyes emoji here, yes bonds have actually outperformed cash over much of the last 40 years as interest rates were almost a one way trade going from the mid-teens for the ten year Treasury down to 58 basis points at its low. That one-way trade is over. Maybe bonds should be bought here (not with my clients money or my money) but not because of what happened over the last 20 years or, more correctly, 40 years. 

“People loved owning bonds because of the appreciation when interest rates declined,” she says. “Now we’re five years out, and people think bonds are terrible.” So people liked bonds when they were going up? Now they don't like them because they are going down. Huh, no one could have known. 

We say it like four times a week here, bonds with duration have become sources of unreliable volatility or as Kristy Akullian from Blackrock said, duration has become an "unreliable source of diversification." The Barron's article made no mention of the type of bond market proxies we discuss here all the time. Here's a chart of a bunch of them compared to iShares 20+ Year Treasury ETF (TLT).

The names don't even matter, we talk about all of these all the time. Since it's Yahoo, it's price only. Toward the left end of the chart when TLT was yielding 1%, the proxies were mostly yielding 3-4%. Toward the right end of the chart. as TLT now yields in the 3's and 4's, the proxies are mostly yielding in the 5's and 6's with less volatility and more reliable diversification benefit for equity exposure. Yes, there are varying degrees of risk but we talk about that as well as pounding the table on the importance of diversifying your diversifiers. 

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 Dumbest Trade You Can Make?

Bloomberg and Barron's each had similar articles about straying off the beaten path toward ETFs that are not the plainest of vanilla. 

According to the Bloomberg article, only 62% of the 1080 "newly launched quant-powered investing styles" showed a positive return going into the end of 2024. That's pretty vague. How many of those funds are inverse? Many of the derivative income funds have positive total returns but can't keep up with the distributions on a price return basis and the article doesn't distinguish between total or price return. 

There is also the issue of timing. Some sort of narrow based index fund is not going to somehow magically go up when its segment is going down. Bonds didn't do well so if any of the funds they are talking about track some segment of the bond market, they might have gone down too. There are some very sophisticated interest rate funds that bet on the curve steepening or flattening. A fund like that might work exactly as advertised but if it's on the wrong side of the market then it too will go down. 

Barron's cited work done by Jeff Ptak and used the word thematic to say that these funds tend to underperform. The poster child for this and addressed in the article is the Ark Innovation ETF (ARKK). The fund was a moon shot to start and has done poorly since. One client owns it on a mandate. I could not talk them out of it. Their timing was good though, it went up a lot, I took their original dollar amount out of the trade and they've been riding the rest mostly down. 

Oddly, Barron's included some industry funds in their discussion of thematic funds and mentioned some that have done very well including iShares Medical Devices (IHI) which I've owned for clients for 12 or 13 years. I guess it could be a theme but is also allowed for avoiding heavy exposure to domestic pharma. I wrote an article for Motley Fool in May of 2004 saying I didn't want to own the stock and spelled out why. Since then, the stock appears to actually be down...21 years later and it's down? The article shows being updated in 2016 but not by me, the URL has the 2004 time stamp. So avoiding something was part of the catalyst to by IHI which argues not a theme but there is a demand component there based on an aging population which argues in favor of it being a theme. 

One that hasn't worked out very well is the IPAY ETF, digital payments.

Something like IPAY, you'd buy it as something you think will outperform the market as opposed to something like a utility sector ETF or maybe some sort of narrower space within utilities or staples maybe. There's a food ETF with symbol PBJ that has lagged the S&P 500 by a lot but has lower volatility, lower beta and was up in 2022. 

I've owned Mastercard for clients since long before IPAY came on the scene. MA has been a lucky holding but someone buying IPAY would probably want to see it above the green line although obviously is was early on. I don't know the fund well enough to know what changed. Also noteworthy on the chart is that while MA has done well over the almost ten years captured in the chart, it has had long periods where it has languished. When you see a stock up a ton over some long period and think I wish I'd just bought and held on, yes that works for the right companies but there will be periods of frustration. 

And finally I found someone who hates bonds more than I do. This Barron's article quoted Joe Sullivan from Allspring as saying passive investing in bonds “about the dumbest trade that you can make.” So, it's not quite the same thing because he is a bond manager but I thought the quote was hysterical. 

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.

A New Variation Of The Permanent Portfolio?

I stumbled into a recently listed fund in Canada whose name checks a lot of boxes for what we like to explore here, WaveFront All-Weather Alternative Fund (WAAV.TO). I don't think it could be bought through a US brokerage firm but there could be something to learn from the allocation. Or not, that's the reason to dig in a little. 

The asset mix is comprised of equities, REITs, gold, bonds and "diversified futures" which I take to mean managed futures. This is the most recent weightings I could find.

Using testfol.io, I tried to replicate it two different ways; global equities and domestic only.

Since I think bonds will be a poor hold for the foreseeable future, I went with T-bills and because I couldn't find a complete list of the holdings, I assumed equities and index futures to be the same and added them together but the notional exposure I have might be incorrect. I am not a fan of broad REIT ETFs. The case for PSA makes sense to me because we collectively own too much junk but I don't own that one anywhere and AMT makes sense for the increased need for towers, AMT is in my ownership universe. 

WAAV seems Permanent Portfolio inspired which is why I threw in AQRIX and PRPFX along with VBAIX as a proxy for a 60/40 portfolio makes sense as a benchmark. 

The results are a mixed bag. Both the ACWI and SPY versions outperformed AQRIX which is sort of a risk parity fund and PRPFX which is the Permanent Portfolio. Neither version differentiates in terms of volatility versus VBAIX but in 2022 the ACWI version was only down 4.84% and the SPY version was only down 4.75% versus 16.87% for VBAIX. The 2022 numbers are of course favorable but they did get hit hard in the 2020 Pandemic Crash. 

This isn't radically different from a lot of ideas we look at. The bigger takeaway is to reiterate that there are countless ways to build a portfolio to help smooth out the ride without taking on bond duration.

The other side of my argument comes from Cliff Asness via Bloomberg who bumped up expectations for 60/40 results by 0.30% annually as he looks for better performance from.....bonds. As Bloomberg pointed out though, Asness made essentially the same call about bonds ahead of 2024 and of course bonds continued to struggle.

I'm not picking on Asness. Bonds do not do what they used to. Why then take on the variable of unreliable volatility as I have been describing it for a long time. For anyone trying to just manage or offset equity volatility, there are countless other ways to do just that with far fewer issues than what bonds have been going through. 

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.

Hating Duration, Learning About Staking

First a new, to me, suite of single stock covered call ETF from a provider named Kurv. They have funds for Apple, Amazon, Microsoft. Tesla and couple of others as well as one for the Nasdaq 100. Their Amazon fund symbol AMZP shows a 27% yield, the Apple version shows 78% but I'm not sure that's right. On price basis they seem to land in between the common stock and the YieldMax equivalent. Here are two examples.

And

There's differentiation there but they don't really look like the common. Like YieldMax, I'd say these don't track their reference securities, they are products that sell the volatility of their reference securities. Similar to YieldMax, they appear to be synthetically long (long call/short put) and then sell a call against that combo. The assets are pretty low in these. The reason to mention these at all is if they turn out to have less erosion because of less yield maybe...maybe...then they could be some sort of incremental step to a useable product. The big idea is how to sell volatility safely. That is a difficult needle to thread but staying reasonably current is how to ultimately decide if they are usable in small amounts for a diversified portfolio. 

Corey Hoffstein Tweeted that he is hearing more advisors say they don't see much reason to own bonds right now but that most of those advisors don't have a game plan for when or how to get back into bonds. For purposes of this post, I will assume the context is bonds with duration which I've been bagging on for ages. They've become sources of unreliable volatility and are now ineffective diversifiers.

I can't see ever owning something like 30-40% in duration. One path to having a meaningful chunk of the portfolio could be much lower volatility. I've said many time that I think people want very little volatility out of their bonds and duration is on a run of heightened volatility these days. Maybe they've always been very volatile but it's more noticeable because the 40 year one way trade lower in rates is now over. Another path back could be yields that do a better job compensating for that volatility. It's hard to imagine getting back to 7% yields on ten year treasuries. Maybe it will happen, I don't know but bonds in the early 80's at 15% were absolutely hated. 

There would be some yield where people would hate bonds due to the huge price declines. A yield close to the long term average of equity growth would be compelling. I'm sure I will continue to write about bonds so if we ever get to the point I describe above, I'm sure we'll talk about it. Sort of chunking around on either side of 5% is not the level I'm talking about. I hate duration right now but it is important to keep tabs on it in case it ever makes sense again. 

The first two items in today's post are about ongoing tracking of market segments that we look at frequently. I'll close out with something brand new for me, so I am on square one trying to learn about crypto staking. Staking does not pertain to Bitcoin which is known as proof of work. Staking pertains to proof of stake cryptos like Ethereum and Solana. Again, I am just learning here but staking is vital to the function of the respective blockchains. 

When you stake your Ethereum you are giving up liquidity, you still own it, in exchange for interest. Although it's not interest like from a bank, you get more of that crypto, Ethereum in my example which appears to yield just under 7%. The role of staking isn't crystal clear to me yet but staking allows for validation of transactions on the respective blockchain. There's been an Ethereum Staking ETP trading in Europe for a while. Here's how it compares to the underlying Ethereum.

The two are close obviously but there is a little differentiation. Maybe that is the staking yield? The fund hasn't had any distributions, it appears to accrue more Ethereum. I'm not sure I have any real interest in buying a version of this that lists on the American exchanges, who knows though, but I am curious to see what this niche could become. It's not difficult to believe that as an income stream of some sort, it differentiates from other income streams. That doesn't mean it should be bought, I don't know. Will these funds somehow accrue "interest" the way client/personal holding BOXX does? I don't know, this is maybe day two on this for me. I knew that staking paid interest, that was it and even then that isn't quite on the mark.

Taking in new ideas is crucial for long term investment success. 

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.