Languishing In Duration & Trend

The catalyst for today's post came from Torsten Slok who noted "unusual behavior" in the ten year treasury after the first rate cute last year.

The green line is the yield going up compared to the average of what has happened in previous tightening cycles. As a reminder, if the yield is going up, then the price is going down. Meb Faber retweeted something from October 2023 where he said "if stocks were down 50%, everyone would be losing their mind. But long bonds are down over 50% and everyone is super chill."

TLH is down 42% from its high and TLT is down 48% from its high. Close to 50% but not quite. While we can't know what will happen, it is a good bet that the declines in these two funds is money that is lost forever and that the declines in individual issues bought at the same time is money that is lost for decades. Slok is pointing out the unusual reaction since the FOMC started cutting or put differently, bonds are now unreliable sources of volatility as we have been describing it here for a couple of years. 

The argument for taking on duration has been reinvestment risk. This thought prevailed for a while but I perceive that this has become less of a concern as all those Fed rate cuts that were supposed to happen, never materialized. Reinvestment risk is the risk that when the note or bond matures that rates have gone down in the interim and that you are then forced to reinvest at a lower rate. The tradeoff is longer duration and all that volatility that potentially goes with it. A one or two year note won't move around too much in price unless something crazy happens but even then, you're only a year or two from getting your money back as opposed to ten or 20 years from getting your money back.

Related, I got an email announcing the Simplified Downside Interest Rate Hedge Strategy ETF (RFIX). The Simply funds are complicated, as is RFIX, but the email explained it very plainly. The fund has a 43 year duration which is longer than any fund I am aware of. 

The primary idea for using RFIX is not 60% equities/40% RFIX, there's not enough Dramamine for that sort of ride. What Simplify suggests as the intended use is replacing a core bond allocation in a 60/40 portfolio with a 6% allocation to RFIX to capture the same effect. This is obviously a capital efficient application of the fund. That leaves 34% left over for portable alpha, extra interest on cash or a combo of the two. 

Obviously, you have to want to core bond exposure generally and then be comfortable with the line item risk expressed in the following chart. Sized correctly, a big drop in small allocation to RFIX would equal a smaller drop in dollars to a larger allocation to a regular core bond fund. 

Just leveraging up fixed income like RFIX or equities in funds like the various 2x SPY ETFs from Tradr seems like a much simpler way to build a portable alpha strategy than blending two different asset classes together along the lines of what ReturnStacked and Wisdomtree among a couple of others do. You'd need to have enough track record to have a basis to believe that Simplify can replicate the exposure they are targeting. RFIX just started trading in December so it's too soon to know but 2x S&P 500 funds have been around long enough for anyone interested in portable alpha to draw a conclusion. When RFIX has some track record under its belt, we'll have some fun with it on Portfoliovisualizer.

Speaking of Tradr ETFs, Matt Markiewicz, head of product development and capital markets from Tradr was interviewed by ETF.com. If you listen, I think there are things to learn but I was most interested by a comment Matt made starting at the 6:29 mark. When asked about new product development, he said they are more focused on "what tools might be useful in a portfolio setting...focusing on some of the broader exposures," broader indexes as opposed to betting on individual stocks using leverage. Who knows what will come of it but I like the idea of focusing on innovation to help portfolio construct continue to evolve. Tradr ETFs' weekly/monthly/quarterly 2x index funds are an evolutionary step. Maybe they will add into the portfolio some day or maybe not but it is important to stay in touch with how these sorts of things evolve. 

And a quick pivot to a Bloomberg article (via Yahoo) that tries to dissect the problems that managed futures has been having since its glorious run in 2022. We've looked at the struggles of managed futures since then, many times. 

Yes, it has been a challenging hold since the 2022 glory. But as I've been saying (occasionally) since maybe 2010, managed futures tend to have a negative correlation to equities. If equities go up most of the time, then maybe managed futures will go down most of the time. When equities go up a lot, it probably doesn't make sense to count on managed futures going up too. 

Managed futures can go up with equities but the point is not to count on that happening. As we've been saying lately, just about any backtest you could run with a large weighting to managed futures looks fantastic but actually enduring a run of languishing is a whole different matter. Just don't with an enormous allocation to managed futures. Diversify your diversifiers. Ideally, a basket of alts will be vulnerable to different things and some will be first responders, some will be second responders and maybe some will be uncorrelated with very little 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.