Which Regret Is Worse?

First up today, Eric Crittenden who is the manager of personal/client holding Standpoint Multi-Asset Fund (BLNDX/REMIX) sat for a podcast with The Monetary Matters Network. There were a couple of very useful nuggets that came out of the show. 

These points are really just different ways of articulating what we've been talking about since long before BLNDX started trading so there is an element of confirming my own beliefs.

First, "no one wants diversification until disaster strikes and then they’re all scrambling for it" but concretely knowing when you'll need diversification isn't really possibly. We've framed this as assessing when risks might be elevated versus other times which is a page from John Hussman's playbook. The criticism of the elevated risk approach is that it's likely to predict 7 of the next two bear markets meaning you end up being too defensive. There is a balance to be struck and there is no strategy where you will feel good 100% of the time. I believe in permanently holding a couple of diversifiers and then being willing to occasionally dial up or dial down that exposure. 

"Risk happens fast" as Mark Yusko has said and to the title of this post, the regret of no diversifiers when you need them exceeds the regret of the drag on returns. 

When asked what problem he's trying to solve, Eric said "every 8-10 years there’s some sort off risk event where clients and advisors have regret that they didn’t have something that mitigated the downside" which is a reiteration of the previous point. A tendency that I've seen repeat from cycle to cycle is that people often forget how they feel in the throws of a large decline. I am telling you that "why do we own that" very quickly becomes "I'm glad we own that." It is worth repeating that if everything in the portfolio goes up together then they are all likely to go down together too. 

The last one from Eric is that "a true diversifier is something that stands up when you need the most" which speaks to a couple of things. Adding something like small caps may add different attributes to a portfolio that can help the long term result but it in no way diversifies equity risk. The other point I think this quote evokes is having the correct expectations about what various holdings will do for the portfolio. The next time the S&P 500 falls 30%, small caps won't somehow go up. Similarly, if the S&P 500 rallies 20% this year, it is not likely than managed futures will also go up a lot. 

The Wall Street Journal had a short article titled Your Fancy, New ETF Might Be A Little Too Fancy. The article was reasonably skeptical about some funds and got some details wrong about other funds but as is often the case, the comments were more interesting. Always read the comments. 

The comments were divided into two camps, one camp saying that the leveraged and derivative income funds mentioned are complete fee grabbing scams and others defending them and tried to point out errors in the article and misguided understanding by some of the naysayers. 

My starting point is the construct portfolios overweighted to simplicity, hedged with a little complexity. There's no reason anyone else should use complex products if they don't believe in them. I obviously do but with limited exposure. There is probably debate about middle ground funds being simple or complex which is in the eye of the beholder. I think of client/personal holding as being simple for example, while the one AQR fund in my ownership universe is definitely complex. 

One misconception about derivative income funds shared by the author and some of the commenters was the criticism that they will not keep up with simple market cap weighting in an up market. That is true but that is not what they should be expected to do. Over the long term they may or may not have some value you deem as additive to portfolio, but keeping with the market is not what they add. That's not me encouraging anyone to use them, maybe they make sense to you, maybe not, but anyone who is curious enough to learn about them and then make a decision might want to understand what they are evaluating. 

Another aspect to complexity is that not all the funds will work as intended. The best example might be the now closed Simplify Tail Risk ETF which had an all-timer of a symbol, CYA. The fund was short lived and just blew up. As we talked about as it was imploding, I believe the strategy was too dependent on using option combos on VIX which proved to be very unreliable versus doing more with put options or maybe they just should have done less with the VIX complex. A little less dramatic complexity that doesn't seem to work in fund form has been risk parity. I don't believe there were any catastrophes, but comment if that is wrong, but Wealthfront closed it's fund and I believe AQR also had a fund that it rebranded to include risk parity but not have that as its sole exposure. 

Doing the work to try to sort these out is both fun and productive for me, but if not for you, don't do it, simple as that. I would reiterate though that I sort through far more of these than I ever use. I have an alts watchlist that I track with maybe 50 names on it in pursuit of using just a handful.

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