Barron's has an article about how to protect your portfolio, er sort of. Basically, after a couple of quotes from William Bengen, father of the 4% rule, about his tactical portfolio currently being 37% allocated to equities, there are a couple of suggestions from William Bernstein about just having less equity exposure.
Portfolio No. 1: 15% U.S. stocks, 10% international stocks, 75% one- to three-year U.S. Treasury bills.
Portfolio No. 2: 15% U.S. stocks, 10% international stocks, 75% split between Treasury bills, five-year Treasury notes, and intermediate corporate bonds.
Then there was this surprising quote from Bernstein;
Over the long run, Bernstein estimates that these 25/75 stock/bond portfolios will trail a traditional 60/40 stock/bond portfolio by at least one percentage point a year. That’s a lot.
What do you think about that 1%? Can that be right? Wouldn't 25/75 lag 60/40 by a lot more than 1%? Well, yes, yes it would. Using testfol.io, we can go back pretty far.
Generally, I always say that if you need growth beyond the rate of price inflation, that you should have some sort of normal allocation to equities. Not everyone needs growth though. It's not that 75% in T-bills must be the wrong allocation but it's not going to trail 60/40 by only 1% unless short term rates get up in the 7-10% range. Where we talk about the importance of expectations, a portfolio that lagged 60/40 by a little with much lower volatility would be desirable for many investors but the idea that 75% in T-bills could offer that is not reality with rates where they are, it's an incorrect expectation.
What about leveraging up the equity exposure with a 2x fund? Keeping the same 25% in risk assets but going with ProShares Ultra S&P 500 (SSO) equates to 50% in equities plus then 75% in T-bills or The Vanguard Total Bond Fund (VBTLX).
If we go back to 2002 with this second back test using ProFunds Ultra S&P 500 (ULPIX) which is the mutual fund predecessor of SSO it looks bad because of how big of a hole any 2x fund would have had to dig out from after 2008 so there's some good context about the risk of any leverage strategy. The second backtest also cuts out the lost decade of the 2000's.
Actually, the lost decade up until the end of 2007 was pretty good for this concept using 25% into ULPIX instead of SSO.
So the problem was the Financial Crisis, this idea unravels holding through the financial crisis. How realistic is it to see trouble like that coming? Usually we address that as recognizing when risks are elevated not wild-ass guessing that a bear market will start. This is a bit of process taken from John Hussman.
No BS, I flat out got ahead of the Financial Crisis. Here are some samples from Seeking Alpha here, here and here. All three are from late 2007 and talk about me calling it a bear market and defensive action I was starting to take. The third article linked is from 11/23/2007 and I say "I am convinced that the market has started to turn down into a bear." There's not much of a content trail available from 2021 but I was holding BTAL and BLNDX for clients (still own them for clients and personally) and derisked a little more late in 2021 when it seemed plausible that congress might actually allow the US to technically default on its debt. I added an inverse fund to client accounts, held it for a while, and the combo of BTAL, BLNDX and the inverse fund helped avoid the full brunt of 2022's large decline.
So as someone who has maybe dodged the full brunt of a couple of really big events, I don't know how realistic it is to see serious market trouble coming. I have a process and am comfortable sticking with it but I don't assume infallibility. For as much as we explore using leverage and the concept of portable alpha, this post turned into a great example of how what appears to be a valid strategy (I do think it's valid) can get done in by an adverse sequence of returns, depending on how it's built. At its 2009 trough, SSO was down more than 80%.
The closest I am willing to get to leverage in this context is leveraging down like having slightly more in equities, hedged with a reliable first responder defensive or a multi-strategy fund like BLNDX where the assets and the strategy give a reliable result.
To counter Bengen and Bernstein, if you need growth then have a normal allocation to equities (repeated for emphasis) and keep some number of months' worth of expected expenses in cash like maybe two years' worth.
The information, analysis and opinions expressed herein reflect our judgment and opinions as of the date of writing and are subject to change at any time without notice. They are not intended to constitute legal, tax, securities or investment advice or a recommended course of action in any given situation.
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