Managing Expectations

A reader left a link to an article at the WSJ about he stocks of the private equity operating companies like Blackstone (BX) and KKR. I'd been meaning to check in on them with a blog post because we've looked at them several times for blogging purposes. They are kind of like tech stocks as we've observed before. They tend to go up more than the broad market on the way up and now they are going down more on the way down.

Any individual name can do anything going forward of course but the odds are good that when the market starts back higher, these will once again go up more than the broad market. Ditto tech. KKR might be a little different as they might be changing to resemble a "mini-Berkshire Hathaway."

There's no shortcut to doing the work to understand the companies but just like a regulated utility stock or soda company are probably going to be much less volatile than the market, tech and the private equity operating companies are probably going to be much more volatile. This is an important thing to understand when constructing portfolios that go narrower than broad based index funds. 

Speaking of expectations, Corey Hoffstein from ReturnStacked Tweeted out the following;

Here's the link to the full thread in which he went on to discuss how their funds managed operationally during the tariff decline and why they didn't have problems with margin requirements from the leverage used by the funds. 

RSSY is 100% stocks and 100% futures yields and RSST is 100% stocks and 100% managed futures. I've have been fascinated by these but also very skeptical right out of the chute. The math checks out and while the timing for these funds to launch was simply unlucky, I can't figure how these make managing a portfolio easier. I've felt this way since before they hit their unlucky patch but where we've talked many times about leveraging up versus leveraging down, the potential utility of portable alpha (the predecessor common term for return stacking) never seemed worth the risk in the context of being an advisor for retail sized accounts. 

Part of the story these funds were built on was learning from what took down portable alpha in previous events like the GFC. Leveraging equity beta with more stock exposure was a mistake to learn from, leveraging into uncorrelated assets makes more sense, it should be safer. It probably should be safer and it really is bad luck that managed futures has done so poorly but in terms of preventing problems, I'm glad to not have to explain this to clients. To the above about expectations, tech tends to go up more and down more so it is behaving the way it pretty much always has. Right or wrong, this would not have been my expectation for RSST and RSSY. 

What about putting it all in....and forgetting about it. Putting it all in something and forgetting is always a fun conversation so what about putting it all in all-weather/quadrant style strategy funds? 

This gives us a chance to check back in on the SPDR Bridgewater All-Weather ETF (ALLW) which has done well since its launch with a 2.1% decline. You can see the S&P 500 is down 7.9% since ALLW started trading while VBAIX has dropped 6.6% (a little less than that for paying out a dividend and capital gain) along with some other all-weather and/or quadrant style strategies. I own a few shares of FIRS out of curiosity, it has an interesting take on the Permanent Portfolio.

Speaking of PRPFX, building a core around that is not a bad idea, there will be drawbacks but it is not crazy. First, it was up in 2000, 2001 and 2002 while the S&P 500 was in the process of cutting half. It was only down 8% in 2008 when the S&P 500 was down almost 40%. In 2022 it was only down 5.49%. Backtests are somewhat skewed because of how well it did in the tech wreck and GFC but in most positive years it has trouble keeping up. That doesn't have to be bad but it would useful to understand that it probably cannot keep up with a big gain for the broad market. 

I threw in AQRIX because we us it for blog posts. If you want to play around with it, remember that it used to be risk parity but they changed it several years back so shorten the backtest. From 2018 on, it has compounded 2.35% less than VBAIX but it's only slightly less volatile. HFND along with ALLW  could work in this context but it might be difficult to understand how the funds are positioned and they also change their holdings which is something you'd probably hope for but if we're talking anchoring around one of these, you might want to understand what you own a little better. 

Putting it all into one of these and forgetting it is not something I would ever do or advocate for but a little more consistent with how we look at things, what about some sort of blend? I compared the following to VBAIX.

It only goes back to October of 2020 but;

The drawdowns;

The results are interesting. It was up 5% in 2022 and this year it is down 34 basis points. With a little more time spent, we could probably come up with a couple of better choices for the constituents of this portfolio but while the overall backtest looks good, the portfolio lagged VBAIX in 2023 by more than 12 1/2 percent and I would expect similar lags in other years where the broad market goes up a lot. 

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.