Endowment Style & Selling Volatility

Meb Faber hosted a webinar to support what his firm, Cambria, is doing with 351 exchanges and the upcoming Cambria Endowment ETF (ENDW). 

351's are kind of like 1031 exchanges in real estate. If you have a taxable portfolio of at least $1 million where selling or rebalancing would hit very hard tax-wise, you can exchange your portfolio for shares in a 351 ETF. You'd have the same cost basis but you'd have better diversification. Go to the Cambria website if you want to learn more. 

Moving to ENDW, we just mentioned this the other day, really just acknowledged that it is coming soon but the webinar added some color. ENDW is going to be leveraged, offering 130-150% of exposure. It's going to use futures to add the leverage but in listening to the webinar and the extent to which it is going to avoid domestic market cap weighted equities, I'm not clear how it will actually leverage up. For example, the fund is going to have exposure to shareholder yield ETFs from Cambria. That does differentiate from market cap weighting alright but I don't think there is a futures market for it unless a bank is going to create some sort of derivative for the effect. That's ok, we'll know more in April.

Here was an interesting slide that gives an idea of ENDW's likely allocation. The fund is expected to have the leveraged version. 

I built out the unleveraged and leveraged version with the following funds, splitting equities evenly between ACWX and SYLD and splitting fixed income evenly between TFLO and SRLN. Based on Cambria's other multi-asset funds, ENDW will probably have fixed income duration but that's a space I will continue to avoid.

The results.

I threw in 50/50 Cambria Global Asset Allocation ETF (GAA)/Cambria Trinity ETF (TRTY) because Meb talked about those two quite a bit as being core type funds, each one maybe even for use as a single fund portfolio. 

The returns of both the unleveraged and leveraged versions are good but there is a good bit of volatility. It's not clear that the volatility make the returns that attractive. We build portfolios here all the time with similar return profiles but with less volatility. Both the Calmar Ratio and kurtosis for both leave something to be desired. Obviously the actual holdings will be different, my attempts tried to be simpler than what ENDW will probably be but I also tried to be true to the equity exposures Meb talked about.

More important than all of that fun endowment stuff is a point made repeatedly during the webinar. The returns of market cap weighted domestic stocks over the last 15 years have been fantastic. They've been remarkably high in a way that could be very difficult to continue on. The returns are not unprecedented, the 1990's were similar as one example but then when it ends, the "backside of the mountain" as Meb put it can be pretty rough. Most of us of course lived through that from 2000 through to 2009. The S&P 500 hit 1500 in March 2000, then again in the fall of 2007 and then the third and final time in January, 2013. That's a long time for a broad based index to not make any progress. 

There were places to make money during that run, most notably foreign stocks and equal weight S&P 500, that ETF came out in 2003 and had very good years until 2008. It then had a huge snap back year in 2009. 

This part of conversation drifted into how things like Permanent Portfolio, Risk Parity and some other portfolios that differ from 60% SPY/40% AGG and which we explore here could rotate back into favor.

And a quick follow up that I meant to include yesterday about GraniteShares YieldBoost SPY ETF (YSPY) that we profiled on Wednesday. 

YSPY sells put spreads on SPXL which is the Direxion 3x Long S&P 500. The YSPY fund page still shows the short leg of the spread as having a strike price of $171.50 so this all makes for a great test right out of the blocks for trying to understand how YSPY will trade. Where selling puts is a bullish strategy, YSPY going down a similar amount as SPY isn't the worst possible outcome but the volume was thin and down 1.86% is far from the best possible outcome. From my perspective, there's no reason not to follow this and try to learn. Selling volatility is a valid strategy generally but you really have to be selective trying to do it in a fund wrapper. And since we mentioned it in the YSPY post, WDTE which also sells puts on the S&P 500 was down 1.41% on Thursday. 

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.

You Don't Need To Leverage Up

Bitcoin has gotten smacked pretty hard lately.

It touched $109,000 a while ago and has obviously backed off considerably. If you scroll Twitter, you'll see a lot of the touts telling people to buy more which always has a we need more suckers sort of vibe. I saw one Tweet from one of the Bitcoin touts a few days ago making fun of meme coins for being made up nonsense. Um, why couldn't Bitcoin also turnout to be made up nonsense that meets the same end as Fartcoin (that's a real meme coin BTW)?

If you've been watching Bitcoin for a while, on the fence about whether or not to speculate/bet/gamble on it, down twenty whatever percent isn't the worst time to buy. Of course it could go much lower which the touts don't seem to be talking about. Speculate/bet/gamble is probably the correct way to think about it. The people who say it is all BS could turn out to be correct.

If you own some Bitcoin already and you're sweating the current decline then you probably have too much. I'm not saying to sell, I'm not sure what the answer is. If you own it at $5000 and you're sweating it, sure, maybe sell a little, or more if you want. That's a harder call if you're in at $105,000 and realizing you might have too much. 

The flow of content about portable alpha continues with another article from Bloomberg. Here's another one from this week, via a paper from AQR that seems to serve up ReturnStacked ETFs on a platter as simple way to access the strategy. We've looked at it plenty of times. It is interesting of course and credit due to ReturnStacked for bringing it front and center. 

Portable alpha blends beta (stock and or bond exposure) via leverage like from the futures markets with some sort of alpha seeking strategy. Many years ago, portable alpha strategies leveraged up with more beta which ended badly in events like the Financial Crisis but now the implementation seems to focus on generating alpha from low to negatively correlated strategies like managed futures, global macro and absolute return. 

Part of the conversation surrounding portable alpha's recent popularity has been yeah leveraging up the beta was a bad idea but now we know better. If you've been reading this site you know I am not a fan of leveraging up. We've looked at what I've called leveraging down. The simplest implementation of leveraging down is probably targeting 60% to equities but bumping that up to 65% by adding in a slice to a reliable first responder defensive like client/personal holding BTAL. Another simple variation would be for an investor comfortable with a plain vanilla 60/40 portfolio putting 67% percent into WisdomTree Core Efficient ETF (NTSX) which leverages up in such a way that 67% into that fund equals 100% into VBAIX. The left over 33% could be put into T-bills and collect an extra 4% in yield (putting 33% into a T-bill at 4% actually adds 132 basis points to the overall portfolio return) and also mitigate sequence of return risk.

If the smart people running portable alpha 17 years ago could get blindsided by leveraging into more alpha, why couldn't the smart people running the new and improved portable alpha today get blindsided by the low to negatively correlated strategies like managed futures, global macro and absolute return not "working" when the next large equity market decline comes along? This is something I've been cautioning about for years. Keep allocations to diversifiers small because none of them should be counted on to be infallible. 

I can't imagine managed futures not working in the next true bear market (anything can happen in a fast panic) but I don't want to rely on not being able to imagine something. 

The AQR paper had an interesting graphic.

Building this out in simplistic fashion looks like this;

We see this time and again, the more important decision in this example is reducing exposure to AGG's duration in Portfolio 3. QSPIX is absolute return with no correlation to the S&P 500. Putting 20% into QSPIX is not something I would do in real life but someone who wanted as much as 20% in alts could build out 20% pretty easily. Dividing 20% in alts between a bunch of uncorrelated strategies reduces the consequence of a random fund malfunctioning and we've removed the risk of extra leverage that would go along with a 60/40/20 allocation. 

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.

Leveraged Derivative Income Funds? Really?

GraniteShares launched a couple of more 2x put selling funds, one that tracks the S&P 500 with symbol YSPY and one that tracks QQQ with symbol TQQY. The product suite is called YieldBoost and the Tesla Yield Boost has been trading for a little while with symbol TSYY.

Specifically, TSYY sells put spreads on a 2x Tesla ETF and it had been holding up better than the underlying common until this latest downturn in TSLA stock. TSLL is 2x Tesla. The drop in TSYY started to track closer to the common when the price of TSLL went below the strike of the short leg of TSYY's put spread. If you don't know what any of that means, you should learn before even considering buying a fund like this and even then, it's questionable. 

YSPY is similar but not identical to TSYY. The fund objective talks about 200% of SPY but its put spread is written on SPXL which is the Direxion 3x fund. I asked the firm about it and was told that the put spread is far enough out of the money that it has the effect of 2x. It looks like SPXL closed on Wednesday at $171.63 and the short leg of the spread shows on the YSPY page struck at $171.5. If those numbers are correct then it's not really out of the money by all that much. 

The Defiance S&P 500 Enhanced Option & 0dte Income ETF (WDTE) is in the same neighborhood as YPSY. It sells 0dte put options obviously and has a very high yield as I expect YSPY to have. I don't know how similar YSPY will be to a leveraged version of WDTE but if it is similar, the following might give a picture of what to expect. 

With 300 WDTE I tried to approximate what selling puts on a 3x fund might look like but that may not turn out to be valid. The bigger takeaway though is probably the difference between the reinvested numbers and not reinvesting. Obviously 3x WDTE is not accurate for how the fund really does and GraniteShares does not expect YSPY to erode 90% in a year and half but in the wrong type of market the erosion could be painful.

Below is a backtest for someone that might need to take a lot of income out via an approach we've looked at before in previous posts that takes the distributions out as income. 

Putting 9% into WDTE with leverage is an attempt to replicate what YSPY might be like but again maybe that turns out to be wrong. 

First, the positives. With both portfolios, there's only 3% of the portfolio at risk of complete immolation. Portfolio 1, the leveraged one, yielded 7.5% in 2024 and Portfolio 2 yielded 5.6%. Putting 5% into unleveraged WDTE would have had a portfolio yield of 6.3%. 

The way I built these, 57% is in plain vanilla S&P 500. The S&P 500 can obviously go down a lot but there isn't a reasonable probability that a fund tracking the index will malfunction in such a way that it will fail. If the S&P 500 goes down 40% and YSPY were to go down 95%, would the portfolio be that much worse off? I'd say no. I didn't use T-bills for the fixed income but you could. 

This is of course a variation of a barbell strategy squeezing a lot of the yield out of a smaller portion of the portfolio. With the leveraged version, almost half the yield comes from WDTE or potentially YSPY if it pans out that way. 

If the S&P 500 continues to generally trend higher the way it usually has, then the erosion of YSPY's share price might not be that bad and certainly, in the average year the growth rate of the 57% in the S&P 500 would outpace the erosion. YSPY will probably have some erosion but the entire portfolio would not automatically be at risk of erosion. To maintain this, some S&P 500 would need to be sold off periodically to buy more YSPY. 

The income paid out by any derivative income fund should be expected to be lumpy. A common poke at derivative income funds is that the "dividends" are often characterized as returning invested capital. If a fund can tread water and pay out a high distribution rate that is not taxable, I'm not sure why that is a negative. From that hoped for frame work, now of course some amount of erosion should be expected. GraniteShares doesn't think there will be too much erosion but I am skeptical of that. If the YSPY erosion was 40% per year as it maintained a large even if lumpy payout, then the required rebalance out of the S&P 500 fund would equate 120 basis points and annualized out, the S&P 500 has of course grown at a much higher rate.

Clearly there are a lot of assumptions here about how YSPY might work. My assumptions could be pretty close, only half right or maybe oh my God how could anyone be so wrong. But that's the point, to be willing to pay attention to a lot of these and to start sifting. The blogging process is great for taking first looks, like we're doing today, and then following up to learn whether some off the beaten path fund/strategy might work. 

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.

Portfolio Quadrants

A couple of quick things today. 

First Meb Faber and Michael Gayed had a podcast that covered endowment style and permanent portfolio among other things. I believe there is a lot of overlap between the two. It seems like many endowments along with other types of sophisticated pools of capital are Permanent Portfolio inspired as Jason Buck said a couple of months ago. 

In the podcast they talked about adding managed futures as a fifth quadrant (quadrant can be the correct word in this case, but it can also be called a quintant as in five quintants). And with the third portfolio, I swapped out long bonds for catastrophe bonds and benchmarked to a 60/40 portfolio.

Just adding managed futures as done in Portfolio 2 brings down the CAGR by 48 basis points but has a very beneficial effect on standard deviation and the Calmar Ratio and small but favorable impacts on standard deviation and kurtosis. The results from Portfolio 3 are far superior for the simple decision of removing bonds with duration. 

There was a quick mention of the coming Cambria Endowment Style ETF. It's not going to be what I was expecting. Apparently the recently launched "private equity" ETFs are trying to replicate the exposure by leveraging up volatile large cap beta. The Endowment Style ETF sounds like it will do something similar. We'll see in April when it is due to start trading. 

Pivoting to a little bit more about ETF models. I found commodity model and an all-alt model a as follows. 

I ran them by themselves and then with 60% in the S&P 500, adjusting each model proportionally to fit into 40% of the portfolio which is how I think they'd be better used and finally benchmarked to a traditional 60/40 portfolio in the 5th one. 

The CAGR numbers for the two models make it clear why they wouldn't work for too many people as stand alone portfolios. But weaving them in with equities certainly improves the growth rates versus putting 40% in bonds but the volatility numbers are mixed bag. In 2022 the two models plus VOO were down mid to high single digits versus 16.87% for VBAIX.

Above you can see that removing all those single commodity funds and just having 40% in USCI had a high return average, yes a little more volatility but in 2022, 60% VOO/40% USCI was up 88 basis points. If you actually consider using a model, it might be worth exploring whether you can get a better result with something much simpler or even the same result with something much simpler. 

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.

Word Association

What's the first thing that pops in your head when I say "endowment style?" Is it this?

The "endowment" result is very close to red line VBAIX every year except 2020 when it lagged by almost 600 basis point and 2022 when it outperformed by about 500 basis points. If any of us had constructed this portfolio and implemented it for ourselves, it would have been a very acceptable result. The portfolio did just fine, it captured most of the upside and avoided the full brunt in 2022's large decline. It did worse in the 2020 Pandemic Crash by 200 basis points which isn't problematic for how quickly everything snapped back. In that event, I think doing better than the broad market probably just came down to luck in reiterates a point I should be making more often that fast declines, aka panics, aka crashes are not be feared anywhere near as much as slow declines which typically take much longer to recover. 

One thing lacking from the "Endowment ETF Model Portfolio" is any hint of endowment-like results. I'm not sure too many investors need endowment-like results and while we might have different ideas about what endowment-like even means, a tight correlation to a 60/40 benchmark isn't it. 

To me, endowment means some sort of relatively high absolute like return that includes equity exposure and global macro. The typical absolute return fund would be doing well to return 4-5% per year, or maybe 6% with rates a little higher through good times and bad. So maybe an endowment would be more like 8-9% through good times and bad. Maybe you disagree with that but I would not expect endowments to take the risk necessary to have lights out hedge fund performance due to the need to pay out a certain percentage every year.

There is a mutual fund niche where the objectives are CPI plus some return like another 2% or 5% on top of whatever CPI is doing so maybe endowments should be thought of in that realm? When I go to look for funds in the niche though, I don't find any, maybe they didn't work? Neither Google Gemini nor Grok on Twitter could find any in the US. I wonder if short dated TIPS combined with a little bit to a 2x S&P 500 ETF could do something close to CPI plus x% or maybe not 2xS&P 500 but maybe just high beta somehow. We've explored that a little in the past maybe that can be another post. 

I think what the Cambria Trinity ETF (TRTY) is trying to do is in the realm of endowment style. It might not be succeeding there, that's could be debated but I think the idea is close and there are others. 

The endowment profiled above allocates 53% to equities, 27% to fixed income and 20% split between six different alternative strategy ETFs. They did a good job with the alts, 5 of the 6 were up in 2022. The fixed income sleeve was 2/3 allocated to a fund with a highish duration so that was a drag on result. The equities had a lot of factor exposure as well as foreign. No beef there, those either work out or they don't relative to simpler market cap weighting but they still got decent upcapture. 

As we've talked about models a fair bit lately, we've tried to find differentiation. I've asked, do you want differentiation if you're going to implement someone's model? My bias is to want differentiation, model or not, that's pretty much the whole point of this site but I had a very cynical thought. Maybe the model providers don't really want their models to differentiate. 

Something like a 75/50 portfolio might fit in the discussion of endowment style. 75/50 seeks to capture 75% of the market's upside with only half the downside. Do the math, it would be a fantastic long term result but very difficult to pull off. If some sort of model provider could actually pull it off though, it would mean lagging every year that market is up which is of course about 72% of the time. "You're going to lag almost every year but your long term result will be good." There are a lot of advisors who would not be able explain the merits of those attributes to clients. Sorry but it's true. 

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.

Are Models A Solution In Search Of A Problem?

Today's post is a continuation from a couple of weeks ago when we looked at model portfolios and talked about differentiation. I found model portfolios from WisdomTree via a Tweet and models from Fidelity via a Bloomberg article. 

WisdomTree has a lot of models, this is just one that leans very growthy.

Fidelity's model included a couple of very new funds so I tweaked it a little keeping the same type of exposure like large cap but the changes allow for a longer backtest.

Then I built the following inline with what we usually work with here. 

And benchmarked to the Vanguard Balanced Index Fund (VBAIX) which is a proxy for a 60/40 portfolio. BTAL and CBOE are in my ownership universe. 

I'm also throwing in the year by year to get a better sense of how much differentiation there is or is not as you see it. 

The Fidelity portfolio seems little more live by the sword die by the sword faring worse in 2022 and doing much better than the others in 2023. That is meaningful outperformance for such a short time but the tradeoff is much more volatility.  The WisdomTree results are shockingly similar to VBAIX. It clearly outperformed in 2022 and then seemed to lag slightly every other year. That result is pretty good I'd say, it avoided the full brunt of the 2022 large decline which counts as a success. 

Neither model uses any first responder defensives but WidsomTree does have a 5% allocation to its own managed futures fund as a second responder. And neither one tries to differentiate with fixed income or fixed income replacements which is a big priority for the fun we have here as well as in real life for my clients. 

Portfolio construction is a lot easier when you can find yield that doesn't have equity-like volatility and it is also easier when you have a little bit allocated to something that will reliably go up when stocks go down. I think of those two items as true points of differentiation but there can be others. I am not too gung ho on too much equity differentiation. For me, the bulk of equity market exposure should be plain vanilla. As I mentioned the other day, if you want to tinker around the edges a little bit fine but whatever you think your equity allocation should be, put it in simple equities. 

There's nothing truly awful about the models we looked at. As we discussed the other day, if you're going to use some sort of model off of a provider's shelf, what are you hoping to get? Whatever your answer to that question is, do you think the model gives a reasonable chance of achieving that outcome?

I'm not against model portfolios generally but there are plenty out there don't offer much. 

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.

New Fund Fact Finding Part 2

Today, a follow up to yesterday's post by plugging the Catalyst/Warrington Strategic Program Fund (CWXIX) and the Rational Tactical Return Fund (HRSTX) into a portfolio as bond substitutes. The primary strategy for both is primarily using option combos to create a T-bill like return similar to client holding Alpha Architect Box ETF (BOXX).The funds have a little more going on with trend and volatility trading than BOXX does. 

First, for a little context is 60% Vanguard S&P 500 (VOO) with 40% in AGG, then CWXIX and then HRSTX for a full bond replacement look. 

There's not much differentiation between the three except for 2022.

Next, we'll incorporate them into the type of portfolio we often work with here. Each of the following have 65% in Invesco S&P 500 Momentum (SPMO), 5% in client/personal holding BTAL as a first responder defensive, 10% in managed futures and the final 20% in AGG, CWXIX or HRSTX as noted. 

Again not a ton of variation most of the time except for 2022 and 2024 where all three outperformed VBAIX dramatically.

While it's nice that the three outperformed VBAIX, the driver of the result is most likely attributable to the top down decision to avoid or at least minimize exposure to fixed income duration. 

As for the correlations of the two funds to a couple of core holdings as well as several other alts;

The yellow highlighted symbols are in my ownership universe. It's interesting that the correlations between BOXX, CWXIX and HRSTX are all quite low. 

This exercise was productive. 

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.

New Fund Fact Finding

The guys at RCM Alternatives had a blog post that was right out of our playbook here in terms of looking at alternative strategy funds as substitutes for plainer vanilla stock and bond exposures. They listed out quite a few funds that I've never heard of so looking at them was fun. Today we'll dig in and see if any of the funds should go on our radar. 

The first question in the post was about how to categorize various types of alts which can be difficult, the article said, with the blending of strategies in one fund as well as the blending of assets classes in one fund. This is where the idea of expectations can help. That's an important question and issue for any holding in your portfolio. For example, a fund with the word arbitrage in the name is unlikely to keep up with the stock market when the stock market is up a lot. An inverse fund is going to go down a lot if stocks are up a lot. When stocks go down a lot, sectors like tech and discretionary are probably going to go down more. Bitcoin is likely to be very volatile far more often than not. 

On this point, we've gravitated labeling alts with influence from Jason Josephiak as first responders and second responders and the third category that I coined was horizontal lines that tilt upward. I guess another type would be alts that are legitimately uncorrelated, that just do their own thing.

The first grouping of funds were intended replacements for 60/40 due to the "limitations" that the current environment poses for the basic portfolio. 

The Standpoint fund is a client and personal holding that I write about frequently. The Q3 All Seasons Tactical has symbol QAITX. In its description of QAISX, RCM refers to it as an absolute return fund but I didn't find that term on the fund's page. It generally has equity and fixed income exposure via derivatives and ETFs and there is an element of capital efficiency here as well. 

The fund is the same age as BLNDX. QAISX outperformed VBAIX by a good bit in every year except 2022. Based on the holdings I see now, I would bet that it got caught with too much duration and it fell 37% versus 16.87% for VBAIX. In doing a quick read through, I was unable to find whether the find might be levered up like PIMCO Stocks Plus Long Duration or maybe one of the ReturnStacked Funds. If so then maybe that decline isn't quite what it appears. Generically, if a fund creates the effect of an entire portfolio with just a 50% allocation, then of course it would go down more in nominal terms in a year like 2022 (expectations).

Also mentioned in this section of 60/40 replacements was RDMIX and RSST. RDMIX just changed its strategy a month ago and RSST is less than two years old so it is too early know whether they can turn out to be replacements for something like VBAIX. 

The next category was "equity replacement" which I am not going to drill down on. Regular equity exposure still works just fine, is much simpler and much cheaper. Some sort of "equity replacement" around the edges to add some sort of attribute or effect, maybe, but in terms of a core exposure, I would not abandon plain vanilla equity exposure. 

Next up, bond replacements. 

I've never heard of either fund but at first glance they do appear to differentiate from AGG which makes them worth looking at. CWXIX, the Catalyst fund, uses option combos to create income along with treasury bills. It seems similar to client holding BOXX. The fact sheet is useful if you want to check it out. The Rational fund does almost the exact same thing. Like I said, they appear to be differentiated and if eyeballing them as being similar to BOXX is correct then it would be worth learning more because they create a pretty smooth ride akin to how people hope bonds will behave. If you play around with those funds, you might want to truncate any backtesting, there's either a distortion in the early years or the funds changed strategies. 

The RCM post closes out with a catch all of "stand alone diversifiers" that includes Bitcoin and Ether products, a couple of trend following funds and funds that short the VIX. Around here, we think of anything crypto related as being asymmetry so size it prudently. We look at managed futures all the time, check out the funds if you want, a couple are new to me, maybe there will be something interesting there. The VIX is very difficult to get right on both the long side and the short side. We wrote frequently about the Simplify Tail Risk ETF (CYA) that I believe shut down for getting VIX trades wrong...although for all I know there could have been no getting VIX right. 

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.

Watch Out For Bull Market Geniuses

We've got a lot to cover today.

First up, have you ever heard the pejorative term bull market genius? Here's an example of a high yield fund that shuttered in 2023. It started many years ago with lights out, 5 star performance and then floundered from there before closing. I'm leaving the name out of it, here though is a comparison to the benchmark iShares fund with symbol HYG.

Bull market geniuses come along all the time which is worth remembering if you're ever tempted to chase some sort of heat like Cathie Wood a few years ago maybe. The opposite of bull market genius might be bear market genius but I would settle for bear market kind of smart guy, avoiding some of the full impact of a large drawdown. 

Jeff Ptak from Morningstar wrote an article dissing using 2x leveraged ETFs noting that so called volatility decay causes most of them to underperform the effect versus their respective reference securities meaning that a 2x Meta ETF won't return anywhere near twice the return of the underlying common stock and it might even lag the common stock on a nominal basis too. For ages, I've been saying that 2x S&P 500 ETFs are the only ones that are fairly close to tracking twice the S&P 500 more often than not.

Any time we have this conversation, I include a similar chart to the above and ask what you think, is that close enough? Putting 100% into the levered SSO is not something I think is smart. The potential application is something closer to portfolio three, where whatever percentage you'd put into an S&P 500 fund, put half that amount into SSO leaving cash left over for some sort of capital efficient strategy. In the times of zero percent interest rates, putting the leftover cash into T-bills would not have made up the 70 basis point difference versus SPY but now it would, but there is no guarantee that the previous 70 basis point lag would carry on in the future. It is interesting to me that portfolio 3 has a lower beta and lower volatility. 

I'm never going to do something like this with SSO but the recently listed Tradr 2x ETFs with longer reset periods of weekly, monthly and quarterly could prove out as a way to actually implement some version of this. They're only a few months old but so far, there's been nothing catastrophic that has happened. Here's maybe a more realistic way of what this could look like.

Portfolio 2 leverages down with 10% in cash while portfolio 3 leverages up with an alternative strategy ETF.

VolatilityShares launched two 100/100 ETFs that include Bitcoin. OOSB owns the S&P 500 and Bitcoin while OOQB owns the NASDAQ 100 and Bitcoin. I figured out a better way to articulate why I am not a big fan of these. If you listen to the ReturnStacked guys talk about their funds that do something very similar to OOSB and OOQB, they talk about needing to be able to dismiss line item risk. Ok but....my understanding of line item risk predates the ReturnStacked funds and pertains to a holding that appears to be doing poorly. Managed futures is an easy one to use as an example. 

Managed futures is a diversifier that fairly reliably has a negative correlation to stocks so if stocks are doing well, you might expect managed future to be doing poorly on a nominal basis although I would argue they are doing exactly what they should be doing, going the other way from stocks. 

The intended use is not putting an entire portfolio into RSSY or RSST. The idea is to put some portion of a portfolio into one or both funds and then the rest into a simpler stock fund as one example. By using RSSY and/or RSST you are getting some of your equity allocation from them. 

I'm sure they both track what they are supposed to track, that isn't my point, but the funds don't look like the stock sleeve of what they own. Fine, line item risk but tell me those two aren't tough to hold when you're looking to them to provide some of your equity exposure.

If you put 50% into SPY and 5% each into RSSY and RSST, to whatever extent they might be stock proxies, they've looked nothing like stocks which I believe makes them much harder to own versus stocks up 15% as a made up example while my stand alone managed futures fund is down 10%. I don't know why someone has to have the leverage but if you do, one of the Tradr ETFs paired with stand along alt funds might be better.

Ricky Cobb aka @Super70sSports on Twitter does a daily poll called Why Not where followers pick a favorite from four totally unrelated items. As an example Stairway To Heaven, Apple Jacks, Planet of The Apes, Moses Malone. It's a fun thing. In that spirit....Why Not...

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.

Golden Era For Risk Parity?

Alfonso Peccatiello Tweeted out the following;

We are not in a 5% world (yet?) for US treasuries but I could see where that level would entice more investors to lock in for longer than a year or two. I would want to see yields up near the bottom end of the normal range of equity returns, like maybe 7%, before I would consider taking on any sort of real duration and even then I don't know if the volatility would be worth it.

But that's me, that doesn't make me correct, maybe you would decide 5% is worth the volatility that goes with duration. My point with is though is if you want plain vanilla treasury exposure, just buy an individual issue not an ETF. Unless there is a BulletShares type of treasury ETF out there that matures, the typical treasury ETF will distribute at the prevailing interest rate.

If you bought when yields were at 5% and yields then went to 2% over the next year or whatever, yes you'd have a nice capital gain but the fund would then be yielding 2%. If rates went from 5% up to 7%, then the fund would pay 7% but the price would drop a lot and unlike an individual issue there is no par value for an ETF to revert to at maturity. The TLT ETF is at $89. It topped out around $170. Yields would have to go well under 1% for the fund to ever see $170 again. If nothing else, a terribly timed purchase of an individual treasury would revert to its par value at maturity. 

Next, an interesting reader comment from yesterday's post that I will try to respond to here;

If the reader is asking me how I value services, ok, I wasn't thinking on those terms, I wasn't thinking about what he describes as subtext. How anyone values things like access to healthcare, how convenient it is or isn't for everyday errands like groceries as well as utilities probably factor into these decisions.

I say probably to acknowledge that they could be important but don't have to be for everyone. We don't have access to good healthcare here. For something acute and not serious then yes there are a couple of hospitals and several urgent cares but we don't have any level 1 trauma centers here, those are in Phoenix and Flagstaff and my physician is in Phoenix. I try to avoid needing healthcare beyond a physical with habits related to diet and exercise. 

The reader mentioned homestead sites in New Mexico that have no services. These properties are also very inexpensive.

The picture is from Ramah, NM which is in the far western part of the state, due south of Gallup. There is a restaurant there, a volunteer fire department and I believe a store of some sort but if you need to make a real grocery run you'd go to Gallup or to go to Costco you'd need to go to Albuquerque for an overnight. The road between Ramah and Gallup has a relatively high number of vehicle accidents though. The picture is from the Airbnb where we stayed for one night. It's on a 100 acre parcel. The property is tucked way back in there off the main road and when we visited, a couple of the other nearby parcels were for sale. 

I don't know if there are any utilities or if the power was generated through some combo of wind and solar. Internet can be had via several different satellite services (now there is Starlink too) and the properties in the area all had their own wells. There are some similarities to where my wife and I live and some big differences. We could be self-sufficient for utilities if the grid failed here, we're on a well, internet is via satellite. The big difference, although it feels like we are out there a ways, we're 8-9 miles from Costco, Trader Joe's and Walmart. Amazon delivers to the bottom of our hill but the delivery times are longer than most other people. 

One other thing about Ramah though, as secluded as it feels, both El Morro National Monument and El Malpais National Monument are both pretty close. 

The reader's last sentence, how do you prioritize those items? Chances are you know what role they play in your life and the extent to which they would influence ever making a big change in life or deciding not to. The point of the original post was about being open to the possibility that it is ok to deviate away from the track that most people go on. Plenty of people think they want something only to achieve it and realize it was not what really mattered to them. 

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 Grass Is Not Always Greener

The Wall Street Journal took an interesting look at the current migration and demographic problems the state of Vermont is dealing with. The state benefitted from something of a get me out of the city bid during Covid but that has started to reverse due some winding down of the WFH movement, high real estate prices and very high property taxes. If you think about those three reasons, you see they have more impact on younger people which contributes to the state skewing older. 

Forgetting every other moving part, the idea of moving to a less crowded area with a slower pace of life near some sort of natural beauty is going to appeal to a lot of people. That sentiment probably captures how my wife and I felt in our 20's as we set out on a path to that sort of outcome. 

The following comment resonated though in terms of behavior we've seen here in Walker as people have come and gone (this still happens, people move here and do not stay very long). 

This is nothing new. Most urbanites who move anywhere out to the country don't stay there, though they try to initially. Only a few will stay and put down true roots. The dumbest move of all, is those who take over a rural B&B and think it will be quaint and cool.

The idea of making a big change in life, like uprooting to a small town, is a pursuit of what is hopefully a better life or put another way going on the assumption that the grass is greener on the other side of the hill. Things will be better if....we get out of the city or I get that promotion or any others you can think of. 

It takes tremendous self-awareness to discern between running a way from a problem and making a well thought out lifestyle change that truly aligns with what you actually value. Unfortunately, I don't have any secret to share about how to get this right. Maybe the answer lies in taking more of an intermediate approach. 

I've told this story before, make fun if you want, but the catalyst for me going from city kid to semi-rural adult was the tv show Northern Exposure. It gave permission to live a different life than what 24 year old me envisioned. I visited Walker on my second date with my future wife in 1991 and realized it was the answer but we didn't land there full time until 2002. 

It took a while to get here and then a couple of more to find my career groove as an RIA but once I did, I knew that was exactly where I wanted to be. The odds of the grass getting greener were pretty low. There's been the occasional job offer along the way but the autonomy of setting your own schedule is worth a lot to me and anything that hinted of giving that up was non-negotiable. I did side gig at AdvisorShares and there were some schedule constraints related to meetings but I was working from home and while I don't know if they realized, it was very part time for me. 

The most important the grass isn't greener moment was of course saying no to being a partner at my old firm. The partners got in a lot of trouble later and I am 99% certain they are banned from practicing again. I didn't think they were capable of malfeasance or nonfeasance but it was clear we did not align on simplicity. I wanted a small practice and they were trying to build an empire. I still have my small practice and the "empire" has fallen. 

Put in a different context, saying no to them turned out to be preventing a problem I didn't even know I would have.

Looking around a corner or two to prevent or solve your own problems is pretty high on my priority list. The idea of waiting around for them to "fix it" is something I cannot do. Some of the scare headlines lately have focused on changes to the healthcare system that, as bad as things have been, will make it even worse. Will it actually be worse? I have no idea but the risk to us is that it does get worse, that access to healthcare gets more expensive, wait times get longer or any other negative outcome you can think of. 

The healthcare system has been an absolute mess for a long time, I certainly have no brilliant ideas about what to do and again, I don't now if it will get worse now but the risk is easy to identify. The risk is it does get worse. This is part of why I'm kind of a health nut, I've always exercised vigorously but have been learning more about the importance of diet for a long time too to minimize the odds of needing to rely on the healthcare system from some point of being desperately sick, needing care but not being able to get it. 

I think this general approach applies to many or maybe even all aspects of life. If you're 50, you should have at least a general sense of when you want to retire how much you might need (rough number is fine) and where you stand in relation to that number. Is there any sort of problem with your numbers adding up the way you need them to? If you've looked at your situation in this type of manner then you've looked around one corner, starting to figure out what you might do about it is looking around a second corner toward solving your own problem. 

Could Complexity Be Better Than Simplicity?

Torsten Slok blogged about how ineffective bonds have been in terms of providing any return or diversification benefits lately in the context of a 60/40 portfolio. He talked about the need to replace bond exposure and stock exposure too but the point he was making about stocks wasn't too clear to me. He said that "there are years when Treasuries are not the correct hedge against downside risks in the S&P 500" which is a conversation we've been having here for years. 

We talk about several different structures that can potentially replace 60/40 as Slok is referring to it. Some version of the Permanent Portfolio which includes risk parity, lately we've been talking about portable alpha quite a bit and the one that I think is the simplest, and closest to what I do in real life, is getting rid of most or all of the bond exposure and replacing it with shorter dated fixed income that mostly avoids interest rate risk and long bond volatility as well as various types of alternative strategies the might function as bond market substitutes, strategies with some degree of negative correlation to equities or some sort of uncorrelated absolute return ideas. 

Right or wrong, I think of endowment style investing as being a similar to the Permanent Portfolio, not so much quadrants but more like disparate asset class segments which gets us to a paper about endowment asset allocation from True North Institute. 

Based on the following excerpt;

I built out the following leveraged allocation, taking some liberty with shortening the duration quite a bit.

The third portfolio is just the Vanguard Balanced Index Fund (VBAIX). QGMIX is a client and personal holding. These portfolios don't really look anything like what we usually play around with here but the results are interesting. 

Despite all the leverage, Portfolio 1 has a very smooth ride including up a lot in 2022. It's only down year was 2018 with a decline of 7.91%. Both True North portfolios also held up relatively well in the 2020 Pandemic Crash which are the max drawdown numbers in the chart. 

I'm not a fan of leverage but that doesn't mean it can't be used effectively. This leverage in the True North portfolio appears to be effective for giving an adequate return with a very smooth ride as I mentioned. It would take a lot of things going wrong at the same time for this mix of disparate asset classes to have a horrible year, more things going wrong than in a plain vanilla 60/40 portfolio. Maybe this is an exception that proves the rule about simplicity being better than complexity. 

And a quick closing note. One of the Bloomberg pre-market newsletters mentioned the brand new Locorr Strategic Allocation Fund (LSAIX) that we've mentioned a couple of times. The context of the newsletter like today's blog post, looking for bond alternatives for a diversified portfolio. And a couple of tidbits about LSAIX that I picked up. The managed futures sleeve is multi-manager. None of the managers are replicators and the fund can be long and short the same market. For example the fund could be long tin based on one manager's slower signal and it could be short based on another manager's faster signal. The alternative to being long and short the same market would be netting the two out but LSAIX doesn't do that. 

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 "Safe" Way To Use A 100/100 Fund?

Yesterday, we mentioned the PIMCO StocksPLUS suite of funds. The PIMCO StocksPLUS Absolute Return Fund seems to play right into what we do here in terms of theoretical portfolio construction. The fund has a bunch symbols, I'm going to go with PSPTX. 

The fund leverages up 100/100, S&P 500 equities and absolute return. Absolute return can be a nebulous concept but the big idea is a low volatility strategy that maintains a relatively even growth rate no matter what is going on in the world. Ideally it would be a very boring hold. Using testfol.io, I stripped the equities out of PSPTX using Profunds Bear Fund (BRPFX) which has been around much longer than inverse ETFs and in doing that, I get the absolute return sleeve compounding at 0.48% per year. I have a feeling that understates the actual return but if nothing else it gives an indication of the behavior of that sleeve. 

PSPTX benchmarks to the S&P 500, it outperforms its benchmark but interestingly it does so with more volatility. The absolute return doesn't reduce volatility which surprises me but that first backtest probably isn't how the fund is intended to be used. In 2022, the first two portfolios were down slightly less than the S&P 500 while portfolios 3 and 5 were down more than the S&P 500. PSPTX also fared worse during the Financial Crisis and the 2020 Pandemic Crash. 

Now, we're getting closer to what we play around with here. Client/personal holding MERFX is merger arb, AQMIX is managed futures, PSRIX is a longer standing floating rate fund with very little volatility that I chose just to extend the backtest. Client/personal holding BTAL is a first responder defensive.

Portfolios 1 doesn't leverage up, it uses PSPTX to allow a larger allocation to PSRIX, more like leveraging down. Portfolio 3 does leverage up, it has 70% in equities, compared to 60% for the others and the numbers reflect the leveraging up to 70% equities. All three portfolios held up much better in 2022, dropping 7, 6% and 9% respectively versus 16.87% for VBAIX. None of them though helped in the 2020 Pandemic crash. Portfolio 3 fell the most. 

Is the leveraging up in the third portfolio worth the extra volatility and the likelihood of larger drawdowns? The concept of leveraging seems to work in this instance with a couple of tradeoffs, there are always tradeoff, so is it worth it? That is of course up to the end user but I don't think the worst case outcome would be catastrophic versus an unleveraged implementation, if something went wrong. The leverage would be a little worse, clearly, I'm just saying it wouldn't be catastrophic.

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 Portable Alpha

Yesterday, I referenced a chart comparing the returns of 100% equities versus 50/50 equities/bonds and 50/50 equities/low correlating alternatives. Here's another version of that chart from the Man Institute.

The timeframe in today's chart is more useful because it gets into the period where retail accessible funds started to become available. The title of the Man article is Why Alpha Matters for Retirement Savers and in it, they make their case for portable alpha. Portable alpha combines plain vanilla exposure with alternatives in such a way that leverages up. The idea is that you get the full beta (stocks and bonds) return with just a portion of the portfolio often with futures or some other form of leverage, leaving dollars left over to add alternatives all in pursuit of better nominal returns or better risk adjusted returns.

There are funds that provide the plain vanilla exposures, with leverage, from WisdomTree, ReturnStacked and PIMCO, there might be others too. The PIMCO StocksPLUS suite of funds are the oldest ones I am aware of. 

The starting point for the Man article is that defined contribution investors need exposure to risk assets for more years and portable alpha to add alternatives, they say, is a better way to do it. 

PSLDX is the PIMCO StocksPLUS Long Duration Fund. I used AQMIX, AQRIX and client/personal holding MERFX because they've all been around for a while and BTAL is also a client/personal holding. 

PSLDX is 100% stocks and 100% long bonds so the 50% allocation in Portfolio 1 plus 50% cash could be thought of as leveraging down to a capital efficient portfolio. The results should equal the third portfolio which is 50% stocks, 50% long bonds and they are pretty close even if not exact. The second portfolio is close to what Man has in mind, a full 100% to plain vanilla beta via PSLDX and then 50% worth of lowly correlated assets on top. The fourth portfolio more closely aligns with what we do here. The "leverage" comes in by using the negative correlation to dial up the equity exposure slightly. 

I think some of the portfolio stats are distorted. Portfolio 4 has middling stats compared to the others but in 2022 it was only down 8.23% versus 20% for Portfolio 1, 17% for Portfolio 2 and Portfolio 3 was down 22%. Those three all have long bond exposure of course and as we've looked at countless times, long bonds are very volatile. Also PSLDX is capable of some huge drawdowns, dropping 43% in 2022 and 33% in 2008. It also fell 37% in the 2020 Pandemic Crash but it took that back in just four months. 

The point is, holding that fund is likely to be a very wild ride. Yeah, yeah line item risk but that is easier to say than it is to live with when a fund comprising half your portfolio is down 40%. Yes, PSLDX has always come back to make new highs but holding a fund like that without have exposure to a couple of very reliable first responder defensives would make those drawdowns very painful. 

A final note is that we didn't really recreate the results from the first chart in today's post but I think that is because of how few funds existed 15 years ago versus now. There's no way to know if repeating this same study running from 2015 to 2030 after a flurry of funds came out in the mid-2010's might get us closer but we can check back in five years. 

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.

Beware Model Portfolios With Unrepeatable Results

Morningstar did a quick writeup on model portfolios. The article wasn't too insightful but there was an example of a model portfolio and then an example of how to customize that same model. I didn't see where the original model came from or where the customized version came from either but there's something to learn from it.

All I tried to do was simplify the portfolio, not do anything to improve it. 

The original model slightly outperformed my simplified version. The customized version was much better than my simplified version but they all lagged VBAIX and all the standard deviations were in the same neighborhood. This sort of modeling is not something I have ever done. Should a model portfolio have any sort of differentiation? They really don't but I am not sure what the right answer is but I might know the right question. 

If you are an advisor and you want to go down this road, I think you need to decide ahead of time whether differentiation is important to you for your clients. It may not be important to you, I'm just saying to figure that out ahead of time. If you are a do-it-yourselfer but are presented some sort of model portfolio, great if you have an opinion about whether you do or don't want differentiation. Then ask whoever is presenting the model why they don't do it the other way. So with the above model, I would ask why there is no differentiation. If I were in the model business, there would be differentiation and so I am saying to ask me why I don't look more like plain vanilla 60/40. 

Also, when looking at models I would suggest being on the lookout for any sort of result that might not be repeatable. We talk about that all the time. If you want to replicate private equity with one of the operating companies like Blackstone or KKR, that might work but the past results for those two stocks are so good that modeling them makes for what I would say is an unreliable backtest. Similarly, any sort or modeling with Bitcoin probably gives an unreliable result. According to Yahoo, in the last ten years Bitcoin is up 39000%. Even if it went to $5 million, that wouldn't be anywhere close to 39000%. What I think you can glean from models that include unrepeatable results are attributes related to volatility and correlation. Bitcoin is very volatile and the correlation to equities is all over the place being highly correlated at times, negatively correlated at other times as well as uncorrelated too. 

One of the above started out 2% Bitcoin, 98% VBAIX ten years ago, no rebalancing and the other is 100% VBAIX. Guess which is which. That result is not repeatable. Bitcoin could be a great hold from here, or not, but the past result is not repeatable. 

The other day, I mentioned the brand new Locorr Strategic Allocation Fund (LSAIX) which is 50% equities/50% managed futures. Locorr sent over a powerpoint presentation for the fund that included the following. 

Going back to 1980 isn't too helpful because the the strategies they are talking about weren't accessible to retail sized investors via funds but the idea is similar to what we've seen before regarding alternatives. 

I put no effort into choosing the alts other than diversifying fund providers. Portfolio 1 isn't the best performer all the time, it doesn't work that way, but it is hands down superior to plain old 60/40 with the S&P 500 and Aggregate Bonds.

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.