Did Capital Efficiency Malfunction In This Decline?

A chart similar to this one of the some of the private equity operators has been making the rounds. 

This is interesting for a few reasons. In a blogging context we look at these stocks occasionally for barbelling returns and because they are beneficiaries of private equity fees, not proxies for investing in PE. If you look at long term charts of these stocks they have been moon shots so the tradeoff to stocks that can wildly outperform is that they can catch the Ebola virus when the market gets the sniffles. Another dynamic that might be weighing the stocks down is the possible ending of the carried interest tax break. How great have the returns been for the Mag 7 stocks for the last couple of years, but so far in 2025 most of them look like they are down mid-teens to mid-20's percent. 

So following up on yesterday's post about trying to learn some things about all the portfolio theory we explore here, let's put the barbell and capital efficient portfolio structures as we've experimented with them through a real world test. The concept of barbell strategies, which are a form of capital efficiency, in this context is sort of borrowed from Nassim Taleb who years ago talked about putting 10% of a portfolio in very risky stuff and the other 90% in very safe things like T-bills. My first introduction to the concept was from my time at Fisher Investments in 2002. I've told this 100 times but two of the smarter guys there talked about how a 2% short position in Nikkei Futures, 98% in cash, equaled the return of the S&P 500. I can't vouch for that being accurate but it crystalizes the concept. 

The first three portfolios are various forms of capital efficiency in that they use leverage as follows. All three are consistent with blog post portfolios we've looked at many times and employ the idea of leveraging down. 

The fourth one is the United Sovereign Wealth Fund ETF I made up the other day except with 4% to Bitcoin as I included in that blog post, and I threw in the Vanguard Balanced Index Fund as a benchmark.

The study period is just year to date but only goes through March 7th. 

The HOOD/NVDA barbell would be down more, HOOD got pasted on Monday but none of the portfolios are catastrophically bad. SPYQ is a levered 2x SPY fund that resets quarterly. Being the middle of the quarter it is down more than 2x SPY. Of the four portfolios we created, the one with SPYQ is the worst of the bunch, down 14 basis points, just a whisker better than VBAIX. The portfolio with NTSX is getting a little help from BTAL which was up 10% YTD as of the end of last week.

When I wrote about the HOOD/NVDA barbell the other day I made the point about the higher flying stocks already being up a lot and saying the idea would hinge on picking correctly going forward but that it might be more plausible going with a sector like tech or an industry like semiconductors and tweaking the numbers. 

One skew favorably impacting Portfolios 2 and 3 is the inclusion of AQMIX for managed futures. We use that one for blogging purposes all the time but its long term record is very middle of the pack. This year though it's having a turn as one of the best performers and is up a little for the year. If we'd used a different managed futures fund, I imagine those two portfolio would have been down slightly YTD. 

To answer the question in the title of this post, did capital efficiency fail on this test? The versions we play around with don't appear to have failed. The more practical application is understanding that most of the return for a portfolio that goes narrower than a couple of broad based index funds will come from just a few holdings. 

Whatever you own in the utility sector for example is unlikely to be a leader in the portfolio over any longer term period. My experience with Next Era Energy (NEE) included a good bit of luck and a result that probably won't repeat. Be careful backtesting anything with a utility sector fund, there's a 17 or 18 year stretch in there where NEE went up 850% which skewed funds like XLU. The reason to bring that sort of unrepeatable performance up is that if you do this sort of portfolio studying and you get a real outlier, either favorable or unfavorable, it makes sense to figure out why. 

If you notice, a lot of what we play around with gets very similar results. I think that helps make the results both explainable and repeatable. We had this come up just the other day in the US Sovereign Wealth Fund ETF post, I backtested with 1% Bitcoin because I don't think those results can be repeated but in going forward I suggested 4% (for blogging purposes only not in real life). That's also why I stuck with managed futures in today's post where consistent with previous posts even though most of the funds are having a rough 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.