Capital Efficiency Or Inefficiency?

Treasuries with duration have been rolling over for a couple of weeks perhaps digesting the pending legislation currently being hammered out in congress and then over the last couple of days, the credit rating downgrade is also entered the mix. As rates have moved higher with the ten year close to 4.60% and the 30 year above 5%, stocks might also be rolling over again. Admittedly, it's just a couple of days so who knows yet if stocks are rolling over or not.

At a similar point after the tariffs were announced, I suggested taking the opportunity to stress test or revisit and revaluate any portfolio strategies or techniques that interest you. These events are great learning opportunities so I want to revisit capital efficiency the way we've looked at it before which is to leverage down as we've described it before. 

The starting point for this post is the Miller Value Partners Leverage ETF (MVPL) which depending on a technical analysis process will either own plain vanilla S&P 500 via an ETF or have 2x exposure. Where equities trend up most of the time, MVPL should be expected to have 2x exposure most of the time. The variable would be how well its signals do going from 2x to 1x and then back again.

The weightings to equities and managed futures should all be the same while the unleveraged portfolio has just 20% in ARBIX which we're using as a fixed income substitute. The fifth one below is just VBAIX.

The period available to study was terrible for managed futures which might be why the results are meh. There's nothing catastrophic with any of the results. The RSST version is a little bit of an outlier to the downside but all of them lag VBAIX. For 2025, the MVPL version is the best performer and the RSST version is the worst. 

If we take out the MVPL and RSST portfolios, we can go back quite a bit further and the results do a little better, thanks in large part to 2022.

Circling back to the result for this year, managed futures has struggled of course and while a 20% allocation is nice and tidy for a blog post, it would be better in real life to diversify your diversifiers. And while ARBIX is a fine substitute for fixed income with no duration, same thing, diversify your diversifiers. Twenty percent in just two alts that way is a bad idea. 

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.

My New Friend, Claude

A reader left a link to a short post from Felix Salmon provocatively titled How AI could end the ETF boom. Ok, you've got my attention but, is this actually something new? A few years ago Schwab starting offering thematic baskets of stocks and if you search on Google you can find several similar products from other companies. 

It's safe to say that at least some of these products use some form of technology to assemble and then maintain these baskets. As AI evolves, some may already be using AI and maybe others soon will. Salmon's post seems more like a report on an evolutionary step not a revolutionary step. 

I played around a little bit with Claude AI from Anthropic. This link may have the output, it is the link I see but I don't know if it will show the results of my inquiry. First I asked it to suggest an all-weather portfolio that included managed futures. It pretty much spat out Ray Dalio's all-weather with a 15% allocation to managed futures. 

Then I asked it what it thought about including global macro and if it thought it was a good idea, how much should go to global macro. It suggested the following.

Claude AI suggested QAI for global macro and I used EBSIX in my version. The rest of my version uses names we regularly use for blogging purposes. BKLN allows us to avoid interest rate risk for this backtest. 

As we often see, a decent portfolio strategy this time from AI that can be improved upon. 

Then I asked it to Build a basket of global publicly traded stock exchange companies which may not be the first thing people would think to ask but is a niche I have been very interested in for probably 20 years. Again, I don't know if that link will work. Claude spat out a list of publicly traded exchange stocks from the around the world but it also included one or two private companies. It left out the New Zealand Stock Exchange. 

"What about NZX Limited? Did you leave any others out besides NZX?" It told me I was right and found a few others in addition to NZX. This was as specific as it got with construction;

Portfolio Allocation Strategy

• Core holdings (40-50%): ICE, LSEG, Deutsche Börse, HKEX
• Growth component (25-30%): Nasdaq, SGX, B3, NSE
• Value positions (20-25%): CME, Euronext, ASX, TMX
• Consider equal-weighting to avoid overconcentration in largest players

Most of these are in Testfol.io.

There are some interesting numbers in the Claude basket related to volatility and Sharpe Ratio. Both exchange portfolios held up much better in 2022.

I'm not saying AI's role is nothing. It will evolve to add some amount of value, maybe a lot of value but I think it is too early to know. I have mentioned before that Matthew Tuttle includes AI queries in his daily email so I am guessing he believes it is farther along than I do and he may be right. Whatever the current state of AI in the portfolio construction process, I would encourage advisors to engage with AI at least a little. 

That sentiment is similar to Bitcoin and the cryptos. I think an advisor should have something to say about Bitcoin when a client asks and I think an advisor should have something to say about AI when a client asks. 

Portfolio managers have been using computer based screening forever so AI doesn't seem that different conceptually, all the better if AI screening is a big improvement over more common screening methods. 

Circling back, I took a couple of names out of the Portfolio 1 backtest to have it go back further and got results that were a little more interesting. 

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.

Quadrant Practicality

A quote attributed to David Swensen that I hadn't seen before.

“As a general rule of thumb, the more complexity in a Wall Street creation, the faster and further investors should run.”

If you read a lot of posts here, you might have read something from me along the lines of allocating a lot to simplicity with just a little bit to complexity. Swensen was the long time manager of the Yale Endowment and anything you might find about how the endowment was allocated under Swensen probably won't look very simple but he was a big advocate of simplicity for individual investors. 

Here's how Portfoliovisualizer builds a simple Swensen portfolio.

And plugging into Testfol.io which goes back further and comparing it to VBAIX.

Swensen did better over the course of the backtest with a little more volatility and bigger drawdowns. From 2000 to 2019, Swensen outperformed 14 times. From 2020 on, VBAIX outperformed four times. I think the difference can be attributed to more duration which hasn't been doing quite as well as it used to and having less domestic equity. 

The portfolio certainly is simple enough but where bonds with duration are concerned, the world got a little more complex in recent years. An investor agreeing with that comment about duration could go a couple of different ways, either go simpler like with T-bills or add a little complexity, tools to manage portfolio volatility in the manner that bonds used to. 

There's no wrong choice but I prefer adding a little complexity with the various tools we talk about all the time here. These include alts that trade in the manner that I think people hope bonds will as well alts that more reliably offset equity declines which we've categorized as first responders and second responders. 

I've detailed the manner in which I work these into a portfolio and maybe you think it is simple or maybe not, it is all relative. One idea that I think marries simplicity and complexity is when we take the permanent portfolio which is equal weighted 25% into stocks, long bonds, gold and cash, and try to update it to adjust to the reality that long bonds are not the reliable diversifier they once were. 

Research Affiliates (RA) threw its hat in this ring with a long writeup about managed futures. They talked about "four pillars" as being "economic growth (equities), income defensiveness (bonds), absolute return (alpha) and trend following (tail risk)." 

Portfolio 1 is an attempt to be true to the RA paper using AGG for bonds. Portfolio 2 uses a bond proxy with client/personal holding Merger Fund.

Portfolios 1 and 2 have been almost identical looking back. Looking forward, Portfolio 2 avoids duration risk. VBAIX has 60% in equities and PRPFX has the 25% equity sleeve but also owns commodity equities and gold so Portfolios 1 and 2 are not likely to keep up with the other two. 

I would imagine that Portfolios 1 and 2 would be more all weather-ish with smaller drawdowns as has been the case in the backtest. They do have a positive real return and having half the volatility of 60/40 would be appropriate for some people like maybe those with a very low risk tolerance or someone far enough ahead of where they need to be that they could be partially in game over mode. 

This quadrant style can be a valid way to go but I don't think it is ideal. We've looked at countless ways to get closer to a "normal" equity allocation but still having noticeably less volatility. This can allow for more growth opportunity over the longer term. 

I would pick on RA's use of the term tail risk in conjunction with managed futures. Tail risk is typically more of a first responder sort of defensive. Managed futures has been a first responder in some events but not all events. And to repeat from many previous posts, in real life, I would not put anywhere near 25% into those alts. Loading up like that exposes the portfolio to unnecessary risks. Diversify your diversifiers.

The takeaway is the potential simplicity of quadrant-inspired portfolio construction. I'm not a fan of literally having four 25% buckets but having four or five tranches in more practical weightings makes a lot of sense. 

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.

Easier Aging

Following up on our conversation about private assets soon being available in 401k plans, Jason Zweig weighed in and he is not a fan. The most interesting part to me was about an interval fund from Redwood Investment Management, located in Scottsdale. Interval funds are easily bought, usually expensive and have limited liquidity for getting out. We've looked at these before, really hitting on the extent to which interval funds (don't) mark to market. 

Jason reported that Redwood owns shares of its interval fund in its mutual funds. A couple of the mutual funds have interesting names and strategies, one of them appears to apply trend following to high yield, but the results are not interesting. There is a systematic macro fund whose year by year results seem show a lot of equity beta. I would prefer any sort of macro fund to be more of a does its own thing alternative without much obvious correlation to equities. 

The question of double dipping the fees is quickly addressed (the mutual funds are not doing that). 

There was no version of the word complexity in the article but I think Jason was trying to sort out the idea of complexity in a portfolio. I would imagine he'd be less inclined than me to include a little complexity into a mostly simple portfolio. The issues with interval funds make them complex complexity. A mutual fund that offers managed futures or some sort of arbitrage are complex but the access and liquidity are not. Maybe selling a mutual fund is a good idea or maybe it's a bad idea but it can be done without hassle. If someone wants to allocate some of their allocation to complexity into an interval fund, go ahead but as is often the case, there are probably cheaper, simpler ways to add the same effect into a diversified portfolio. 

The FT had a depressing article titled America's Sickness Economy.

The US is spending more money to get inferior outcomes. The short version from me is that our diets are terrible, we do not exercise and we are terrible at treating the chronic maladies caused by our terrible diets and lack of exercise. It has been getting worse, not better, for many years in terms of lifestyle and our political system has been making it worse. I've never been a fan of any politicians but the entire system has become far more dysfunctional than it was in previous decades. 

This has been an area of interest and a topic of conversation here since the start of the original blog site back in 2004. I hope I've come to know and understand more than I did but either way, 20 years have gone by and as opposed to making any progress, things are much worse. Twenty years is a decent chunk of someone's life. Anyone who has been waiting for them to fix it has squandered those twenty years as opposed to trying to prevent/solve their own problem. 

We learn as children that we need to exercise and we learn as children that we should not eat too much sugar. So there's nothing new but still we do not exercise and we do eat too much sugar (and processed food). The list of problems that can be solved and conditions reversed by getting serious about diet and exercise is endless. And even if you don't want to dig in on how that all works, on some level, everyone knows to cut back on sugar and get some exercise. 

Every aspect of aging is easier when you're healthy, fit, have good body composition, can bend down and pick up heavy things, don't have to spend a lot of time at the doctor's office and not taking a bunch prescriptions. 

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.

Timing Vs Risk Assessment

Before Justin Walters and Paul Hickey founded Bespoke Investment Group, they worked at Birinyi & Associates. This was around 2005 or 2006, something like that. They did a weekly survey of bloggers, bullish and bearish, I recall this starting very close to the start of the bear market associated with the Financial Crisis. Every week for more than a year I was bearish. Bearish, bearish, bearish, week after week and I believe I was deemed as being the most accurate of the group. 

Then at some point I flipped to bullish, probably very close to when this article posted at Seeking Alpha on 12/28/2008 titled 2009: Expecting a Massive Rally. When I did switch to bullish for this survey, Paul and Justin mentioned in the email that went out asking for survey participants to respond. I don't recall how much longer the survey went on but I am pretty sure I stayed bullish for the duration until the survey ended. 

This is similar to how I have viewed and blogged about the middle of the yield curve and further out going back close to 20 years. Locking in for ten years at 4.50%-5% (this was 2006 and early 2007) made no sense to me. It seemed like not enough compensation for the potential volatility and then yields went lower for many more years. Then of course yields bottomed and started to go higher causing pretty big price declines in long dated bonds and many bond funds. I certainly missed capital gains by avoiding that part of the bond market but I am not looking to bonds for capital gains. For me, bonds are about mitigating the volatility from the equity portion of the portfolio, the portion where I do want capital gains to come from. Cool for anyone who is looking for gains from bonds, that's just not what I am looking for. I am looking for yield, yield equivalents and predictability. 

Neither of these seem like market timing in the manner in which the phrase is commonly used. Please leave a comment if you disagree with that contention. 

The prompt for all of this came from the following thread.

Elsewhere in the thread, Corey mentions LDI, liability driven investing where durations/maturities are matched to income (liability) needs. LDI is typically associated with pensions and maybe also endowments. I'm sure Corey is using the term in the correct context so then it is up to the end user what they want to do. Trying to time interest rates is definitely very difficult to do with any consistency. The yield on the ten year Treasury is 4.41% as I type this. Someone says they're going to go in in at 4.75% or sell at 4.20%, that is a short term strategy that is a form of trying to time interest rates. 

What we argue for here is assessing risk. I've made comments here and there about maybe 7% being an attractive point where risk for longer term bonds would be fairly compensated. Maybe it would 6.5% if we ever got there or maybe 7.25%? I'm not expecting anything like that, more like if it ever happened, I would be interested. 

If/when the Fed starts cutting, how low will they go? I don't know but I'm pretty sure it won't be zero. I'm pretty sure it won't be 1% either. I'm less certain about 2% but that seems like a stretch unless there is another calamity that extends beyond capital markets. When Fed Funds were at zero, there was yield without duration available in the threes and even into the fours. If Fed Funds goes down as low as 2%, there will be yield without duration in the fours and fives, probably higher but you need to spread your exposures around. 

In that context, I draw a much different conclusion about needing to match LDI in retail sized advisory client accounts by locking in ten years at 4.41% for treasuries or 5.4% for A rated corporates (per Fidelity). 

Ben Hunt had a doozy of a thread that led him to conclude that we are in for a stagflationary outcome. As we mentioned the other day, Torsten Slot said that in the face of stagflation, we should expect interest rates to go up and stocks to go down. 

We've been talking a good bit about quadrant-inspired portfolios over the last few months and if Hunt and Slok turn out to be correct about stagflation, the concept will probably get a lot more attention.

I built out the following variation on a quadrant portfolio to compare to VBAIX which is a proxy for a 60/40 portfolio and inflation. I didn't know this was available but I typed in the work inflation and there is was.

A portfolio with 40% equities is not very likely to keep up with one that is 60% equities but that isn't the point. The quadrant inspired portfolio above will hopefully be more resilient in times of strife. In 2008, it was down 13% versus 21% for VBAIX and in 2022 it was down 4% versus 16% for VBAIX. For what it's worth, the Permanent Portfolio Fund (PRPFX) was down just under 9% in 2008 and in 2022 it was down 5%.

The long term CAGR for the 40/20/20/20 versus PRPFX being almost identical is interesting but 40/20/20/20 had considerably less volatility. The real return of the backtest is pretty good and would become important if we do go through a lost decade or stagflationary event. 

In the real world, I would diversify the diversifiers and I would split the 40% to equities to include foreign stocks. 

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.

Fear Of Commitment

Price Action Lab had a blog post that amusingly referred to managed futures as being a long term commitment. That led to an older post that tried to figure out the optimal allocation to managed futures. 

Basically, they said to get the highest return you should have zero in managed futures and if you want the best Sharpe Ratio (risk adjusted return) you should have 75% in managed futures. The 75% number was put out there in jest....I think. The more serious point was the human behavior of wishing you owned less when equities were ripping higher and wishing you had more when equities were falling, except this year? 

First as a reminder, I would never have anywhere close to 25% in managed futures but the point of the chart I built is to show that there may not be a single optimal allocation to managed futures that will work in all seasons. With all four of the above being backtested, the returns were driven by equity allocations, 65% in equities will hopefully outperform 60% in equities and so on. I couldn't get the 25/75 blend to the highest Sharpe Ratio so I am not sure how Price Action Lab got there. 

As someone who thinks managed futures is a great diversifier that is pretty reliable (not infallible), I view it as potentially a source of crisis alpha with a low to negative correlation to equities. In that light, 20% or 25% makes no sense to me. We talked at length in 2022 and into 2023 when managed futures was booming and people were coming out of the woodwork to suggest huge weightings to managed futures which I said was a bad idea back then and is a bad idea right now in terms of constructing a portfolio. If you are trying to trade a bottom, I have no idea what someone should do. 

There are some funds that blend managed futures in with other things. There are different funds that do this with different effect that may or may not be additive depending on how you view things. BLNDX is one that I think blends it in with an additive (positive) effect and there are other funds I believe don't blend managed futures in with a positive effect.

Most client accounts have a stand alone managed futures fund and the weight is low single digits. Most client accounts also own BLNDX in a similar weighting. I think of BLNDX' outcome as benefitting from managed futures more than being a proxy for managed futures but anyone else might think of it differently.

I am confident that in the next crisis managed futures will work but a little bit can go a long way. Spreading across several holdings that can offer crisis alpha instead of concentrating on just one makes for much better diversification and offers much more resilience as this year has clearly shown us. 

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.

Private Equity In Your 401k? Just Say No

We have a couple of different articles about private assets being available or otherwise worked into 401k plans. 

First is 401k provider Empower starting to rollout private equity, credit and real estate into plans they offer, ranging from 5-20% allocations. This quote made my eyes bug out. "Wall Street firms have been pushing to get private investments into the hands of individual investors, and they see the $12.4 trillion market for 401(k)-type retirement plans as crucial to this growth."

I'm always going to read something like that to mean we need more suckers. To call the current goings on with private equity and private credit a bubble as relates to giving individuals access probably isn't correct, I don't think the space is big enough at this point. The entire private credit and private space is probably large enough to be a problem akin to a bubble but I'm not sure there's enough homogeneity to tie it all together into a systemic event like mortgages through the banking system.

The first time I was on CNBC it was to talk about solar stocks. I was asked if the group was a bubble. I said no because it was too small to be a bubble. The whole group could disappear without making a dent in the stock market. The better word was mania. I think private equity and debt is closer to a mania on that scale. 

But, if you like private credit then you'll love leveraging up 4-1 to buy it in your 401k through a company called Basic Capital. Here's the gift link from Bloomberg. The very short version of this is that 15% goes into an equity index fund and 485% goes into private credit. The yield from the private credit should more than cover the interest expense, there is interest, and the fees and the yield that is left over, when levered up and combined with the modest exposure to equities should give a low double digit return. 

I really am simplifying that. 

This is of course interesting stuff. It might be insane but it can be interesting and at a high level is a building block for risk parity. 

The four portfolios put 15% in the S&P 500 and 485% in the fund named in the portfolio. I played around with some other funds too. The drawdowns can be brutal and although the backtest doesn't show it well, just about all of the different portfolios did endure some really big declines. 

The program doesn't have margin calls though. It is treated more like a mortgage (read the article). 

Equal weighting the four (subject to rounding) and then comparing to VBAIX.

There's a little less volatility and quite a bit more growth but there was no crisis alpha in 2022. The drawdown that year wasn't catastrophic compared to VBAIX but was a little worse. If this levered 401k platform really does invest in private credit then the risk of statement shock would be less because of how private assets (don't) mark to market. Cliff Asness calls this volatility laundering. 

There wouldn't be a problem unless....

It would be difficult to get used to not getting at least daily marks on something like this. I am not saying people should check their 401ks every day but any day that someone does check, the information should be current. 

Usually when we look at these sorts of complex products I will say that whatever you're trying to do, there's probably a simpler and cheaper way to do it. The closest I can think of to replicate this in a simple fashion would be 15% in an S&P 500 fund at 85% in the Simplify Short Term Treasury Futures Strategy ETF (TUA) which leverages up the two year treasury 5x. When I plug that combo into Testfol.io, it only compounds at 1.70%, far less than the blend we looked at and VBAIX but with more volatility than both. The intended use for TUA is for capital efficiency not for leveraging up like this.

Some of the AQR funds do different things with leverage but the to the best of my knowledge those funds are more balanced like maybe 400% long and 300% short. 

The strategy that Basic Capital is offering is legitimately interesting but I don't believe there is mechanism where the strategy could exist in a fund at least for now. I am going to naturally be biased against using something so complicated, illiquid and expensive. I can't get to a point of thinking the potential reward is worth the risks.

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.

Have They Lost Their Minds?

That is how I would sum up the comments replying to a Barron's article that suggested looking at Permanent Portfolio style allocation of 25% each into stocks, long bonds, gold and cash. This is right in our strike zone of fun things to look at. 

Like with many articles/commentaries, as opposed to taking it literally at face value, it is far more constructive to try to pull something that could be useful to dig in on. Lately we've used terms like Permanent Portfolio inspired (I think Jason Buck came up with that one) and quadrant-ish which I came up with.

To the comments, yes having just 25% in equities won't be optimal for most people. In the quest for more resilient outcomes in times of market turmoil, having 100% equities as many of the commenters implied they had is certainly valid for the long term but very difficult to endure in the short term. The periods of difficult to endure is when mistakes happen.

Clearly, no attempt at resilience can be infallible but I do think being reliable most of the time is possible. 

It might be debatable whether we've gone through a full cycle from the start of 2020 but it certainly has been a full five and a half years. Neither PRPFX nor client personal holding BLNDX has as much equity exposure as VBAIX but there are signs of resilience over the course of the period studied. 

As strong as I think BLNDX has been for most of its existence, there obviously have been long sideways periods and this year certainly has been a stinker relative to its history which is a great example that nothing is infallible. 

Crazy busy few days here so short post tonight. 

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. 

Hedge Funds Seeking To Derisk?

First, three quotes from various articles over the last few days.

"While much of the $4 trillion hedge fund industry now aims for steady returns to cater to risk-averse clients such as pensions, Haidar runs a high-octane strategy where double-digit gains or losses are frequent." 

That first one was about the Haidar Macro Fund which fell 25% in April. I thought the assertion that hedge funds might now be catering more to risk adverse investors was interesting and reiterates the importance of the proper time horizon for whatever it is you're trying to achieve.

“Investors started to add some resiliency to portfolios...”

And

"...lessons in the risk of making hasty decisions during an era of whiplash market swings."

Sorry if the context is a little difficult to read but both quotes address reacting to market stressors which will be much harder to do in case emotions are dictating an investor's actions. Managing a portfolio is a series of decisions and it is not possible to get 100% of those decisions correct. If some number of decisions are going to be incorrect then the focus shifts to minimizing the consequences of the incorrect decisions. 

Reacting in the middle of a panic by doing something big will increase the odds that an incorrect decision will have an outsized, negative consequence. When things were at their worst in April, I tried to convey the idea that selling at that point was a bad idea. Obviously, the index action back then tells us that people were indeed selling. Someone shaving down their equity exposure by a couple of percent, to appease the market gods, may not have been optimal but could have provided emotional relief without creating a serious problem that needs to be addressed, possibly with another emotional decision. 

Contrast that with selling down half the equity exposure. Now what? Is the tariff market event over? What if this person gets back in and the market immediately whooshes lower? Many years ago, I used to say that finding out you had too much equity exposure after a large decline is a bad spot to be in and that is probably what happened to people who did meaningful selling early last month. 

Sprinkled in with all of the face melter, leveraged ETFs that have been launching have been some more all-weatherish funds and some asset allocation funds tying in to the quotes above. We talked about it once or twice before it listed but the the Cambria Endowment Style ETF (ENDW) started trading on April 10th. It's an actively managed funds that will include equities, fixed income, real assets, and alternatives and will leverage up by 30-50%. 

The fund has a lot of holdings and for now the factsheet doesn't have a lot of detail but as I tried to assess the holdings it occurred to me what I thought I was seeing. 

NTSX is the WisdomTree US Core Efficient ETF aka the 90/60 fund which leverages up such that a 67% weighting in it equals 100% in a 60/40 proxy like VBAIX leaving 33% left over for alpha seeking or leveraging down. The difference between the two as far as I can tell at this point is that ENDW can own some alts (it has a couple of different managed futures funds currently) and commodity exposure (real assets). Without knowing how often the fund is repositioned, the exposure to alts and commodities appears to have not been a point of differentiation but it may not be that simple. Either way, with just a month under its belt, it looks exactly like NTSX.

I think I was expecting ENDW to be a little more quadrant-ish but so far that hasn't been the case. 

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. 

Inflation Fighting

Unusual Whales Tweeted out the following.

That is inline with one way we've expressed inflation math before, that with average 3% price inflation, expenses would increase by 50% in 15 years. In a related note, Barron's wrote about harsh Medicare reality (there are some scary nuggets in the comments too).

Do you think your expenses have gone up by 60% in 20 years? Have they gone up more? Maybe less? Very anecdotally, I would say it's pretty lumpy. We (my wife and I) feel price inflation most in the various types of insurances we have. The are all up a ton, way more than 60%. Health insurance of course has gone up an insane amount, just this decade our home owners would have more than quadrupled but we found coverage elsewhere so it has merely tripled. Our various utilities haven't really gone up that much, home heating propane has been floating between $2 and $3/gallon for a long time, gasoline has spent the vast majority of it's time between $2.75 and the high threes in our neck of the woods for a long time too. 

How bad is food inflation? We made some changes to our diet quite a few years ago that would have resulted in our spending more money even if there was zero price inflation for food so I may be out of touch. I realize eggs went crazy, have come back down some but are not where they were. There used to be the saying that there's no getting out of Costco for under $100 and now for us it's $300. Meat from Costco is much more but I don't know if other things have gone down. Healthy food is literally the last thing I would cut back on so if you can add better color in this point, please leave a comment. 

What about healthcare costs? Not insurance but the actual cost of care and medication? According to Grok, the average 60 year old man takes 3-5 medications. According to the NY Times from 2019, people in their 60's take 15 medications. I suspect the real number is in the middle. When we run medical calls, part of the process is to ask what meds they are taking and based on my limited observation, I would say 6-8. 

In trying to find those data points I found something that said someone who takes medication for type 2 diabetes is probably taking meds for 4-5 other conditions. Other than my direct observation, I can't vouch for any of the stats but I think it is common knowledge that we collectively take a lot of different medications and that can be a lot of money.

The way my food expenses have gone up could be considered a form of lifestyle creep. Having to take more medications as you enter your 60's could be another form of lifestyle creep. Both of these differ from the common use of the phrase which usually pertains to trading up houses and cars. 

As people get close to and then into retirement, hopefully the mortgage payment goes away. I realize carrying a mortgage into retirement is far more common now but not having to pay that $1000 or $2000 or whatever each month makes the retirement math much friendlier. An even less predictable variable these days is the extent to which people have to financially support their grown children as they start out on their adults lives. I am not judging even a little bit but this issue clearly is more prevalent than it used to be. 

I am personally motivated to never have another car payment again. A little over a year ago we upgraded to a newer 4Runner from our 2003 without borrowing so we now have the one new car and my old Tundra. Hopefully whenever the Tundra is done we will again able to buy without a loan.

No mortgage and no car payments starting late working years/early retirement years should be able to offset rising prices for other things like insurances, food and wherever else you feel inflation. If you need any work done on your house that is beyond your scope, that will probably be a lot more money.

Circling back now to medications which I harp on, frequently. Getting daily carb consumption down to 50/day or less along with cutting back on boxed processed food from the middle of the store will solve/reverse a lot of metabolic health issues. The list of metabolic health benefits from lifting weights is almost endless. There is no downside to less junk food and there is no downside to better fitness.

How much easier can someone's retirement finances be if they are spending zero on prescriptions? How about simply needing fewer prescriptions? We all know people our own age who can barely move and others who are absolute specimens. The difference between the two in most, not all, cases comes down to habits. 

It's difficult to be confident that price inflation can slowdown anytime soon so opposed to waiting for them to fix it, I would much rather find things that might effect me directly and fix them myself.

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. 

Buffer Battle Escalates!

The starting point is a paper written in March by AQR that went after buffer and defined outcome funds pretty hard. Yesterday, I blogged about the latest response, there have been others, from Karan Sood who appears to be one of the inventors of the buffer fund concept. So when I wrote yesterday's post, I didn't know that AQR came back to the table to refute what I presume is Sood's arguments, Sood was never mentioned by name. Here's the link to yesterday's writeup from AQR. 

Read it all if you haven't already and are interested but I don't want to reiterate my general opinion about this type of product but in yesterday's AQR piece there was a line a reasoning that I do want to look at more closely and take issue with. 

If you click through to read the piece, I am talking about Section 4: Stocks Aren't The Right Benchmark, Bonds Are. Part of the argument AQR is refuting is that some (all?) of the buffer funds are better compared to bond funds, they should be thought of as bond substitutes. The Innovator Defined Wealth Shield ETF has the symbol BALT which they say stands for bond alternative. AQR's reasoning for this includes 

First, a benchmark should be related to the fund being benchmarked. This is why the benchmark for investment-grade bonds isn't commodities, and why the proper benchmark for hedge funds isn't 100% stocks. If a buffered fund is long stocks and options, why would bonds be a relevant benchmark? Why not stablecoins while we're at it?

I look at this much differently. Certainly a benchmark could be mismatched like they say about hedge funds and stocks but we look at proxies for asset classes all the time. Merger arbitrage for example can absolutely be a substitute or a proxy for certain parts of the bond market. Merger arb will have its own risks, it clearly is a different exposure versus buying bonds but it certainly functions as a fixed income replacement. Likewise with client and personal holding PPFIX. The strategy sells index puts that are very far out of the money. That is clearly a different exposure than bonds but trades just like certain segments of the fixed income market and again has its own risks that differ from fixed income. 

So does BALT function as a substitute for fixed income? The following backtest has 60% in an S&P 500 ETF and the other 40% in the fund listed in the name of the portfolio.

The stats for the BALT portfolio versus AGG and TLH are not that different. The TFLO version does differentiate. In 2022, the BALT version was down 9.90%, TFLO down 10.12%, AGG down 16.12% and TLH down 21.01%. BALT will have its own risks that will differ from regular fixed income exposure but there is something to the idea. I still think there are better ways to do this as I've been writing about for years but it seems reasonable that someone might want BALT and a bond alternative. To the AQR point, BALT is not intended to be a proxy for the equity market, it uses equities along with options to create an effect that differs (lags) from plain vanilla equities.

I am not converting to the buffer side of the argument but I think this is a better way to look at them. Almost all of them underperform plain vanilla equities. Ok their objective is not to keep up with plain vanilla equities. I think this is the correct way to look at them and then make a decision which for me is no. Whatever someone is trying to achieve with a buffer or defined outcome, I believe there are better, cheaper and simpler ways to do it. 

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. 

Buffer Funds Punch Back!

A lot of good stuff today starting with the Excess Returns podcast with Jack Forehand and Matt Zeigler. They did a best-of with clips of various people weighing in on changes (or not) to 60/40. Quite a few of the ideas are things we've been talking about here for many years so while this might just be a confirmation festival for me, I would say that some of what they talked about added some nuance to the conversation we have here.  

Bob Elliott said that 60/40, with the 40% in bonds was optimized for the 40 year bull market in bonds that ended in late 2021 and that the next 40 years will be different. We need to think about wider outcomes going forward which is what we are continually working on here. Other than 1981-2021, bonds never did anywhere near as well which brought up the question, what if 60/40 was just luck? I've never thought of it that way before but it would undermine a lot of assumptions. 

Rick Ferri was in there. He said the industry wants to make portfolio construction complex, that complexity is job security. There is absolutely truth in that statement. I try to be consistent in saying that just holding onto an index fund no matter what is clearly a valid strategy but like any valid strategy there are drawbacks. Ferri is very much index fund and hold on, my process is a lot of simplicity hedged with a little complexity with bits of process from various sources added in over the decades and you probably have your own process that works for you.

Cliff Asness was also featured, talking about using higher volatility diversifiers in smaller weightings. BTAL and SH fit that bill as would some VIX and tail risk strategies. He said most products target modest volatility which would include merger arbitrage and macro strategies. Managed futures and equity long/short have a foot in each door and times displaying different volatility characteristics. 

Getting a little more in the weeds, he said that allocating to alternatives with too little volatility by pulling from equities will result in a lower Sharpe Ratio but higher volatility alts can improve Sharpe Ratios and that small weightings will have trivial impact when they do poorly. If you've been reading me for a while, you've seen me talk about a little bit going a long way forever which is what Cliff is saying. I do prefer to incorporate alts with different volatility characteristics into the portfolio which is a point of differentiation from Cliff's comments on the pod. 

I've seen a couple of Tweets lately from Karan Sood who as best as I can tell, is one of the inventors of buffer funds. He appears to be responding to the AQR takedown of the concept from a few weeks ago. Sood put together a backtest for a long but worthwhile thread. 

Testfol.io doesn't show SPRO as being the symbol for a buffer fund. Gemini thinks that BUIGX is the oldest 10% buffer fund so I took that a built the following.

Using BGUIX, I could not recreate the result that Sood got but the time frame is different. The reason I went with 25% in client/personal holding BTAL is that I was trying to match the volatility of 100% BGUIX. The big conclusion from AQR is just own less equity to get the same result as a buffer fund which I generally agree with but I also believe that some index/BTAL mix creates the effect of lowering volatility without capping the upside of the entire portfolio like with a buffer fund. Sood's argument focused on betas not being static which is correct of course but I think that has far less importance than having less equity or adding BTAL in some weighting. 

Alpha Architect hosted a podcast featuring their model ETF portfolio which is a mix of their funds and a few outside funds. They said they only have one model but in different weightings as follows.

For this post, let's work with the 60/40 version to be consistent with most other posts and see if we can get anything interesting from their idea. On the surface they have very little in fixed income. SCHR is straight fixed income with some duration, that fund was down about 12.5% in 2022. We've talked about Tail Risk CAOS quite a few times. It is mostly box spreads which is a T-bill proxy with a couple of different put overlay strategies mixed in. I've described it as possibly acting like a tail risk fund in fast events but that in smaller events it may not, I will say they appear to have solved the bleed issue associated with other tail risk strategies. 

HIDE is trend-like but it is either in real estate via VNQ or it's not and it can also be in commodities or not, based on the trends of each so it looks at far fewer markets than typical managed futures. Right now it is VNQ, SCHR and T-bills. So the model has a heavy weight to alts if you think CAOS and HIDE are alts. They spent a lot of time differentiating between slow declines and fast declines which we've been talking about forever here and wanting defensives to respond to each one. 

Alpha Architect believes in momentum and quality. The dividend factor is not the same as quality but maybe it's quality-ish? ACWX is certainly simpler than using three ETFs for foreign exposure but may not be better. BTAL as a proxy for CAOS speaks to Asness' point about lower weightings to more volatile alts. BTAL is far more volatile than CAOS and I believe more reliably responsive to declines. AQMIX for HIDE is just a straight across the board trend for what they think is a variation on trend and TFLO instead of SCHR to remove interest rate risk.

In 2025, their model is up 1.57% through yesterday, the replication is up 2.79% and VBAIX is down 1.71%.

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.

Digging Into Interval Funds

Bill Ackman has been in the news a lot lately including his opinions about the hole that Harvard finds itself in. He thinks they will have a lot of trouble trying to sell any of its illiquid holdings that they have talked about as sort of a break glass in case of emergency action as they confront the possibility of losing federal funding. From the Bloomberg account of this story, Harvard has about 40% of the endowment in illiquid alternatives. Ackman believes the haircut involved with trying to sell could be about $13 billion. 

Coincidentally, I got an email touting the Denali Structured Return Strategy Fund. It is an interval fund which means it can be bought easily enough with symbol DNLIX but liquidity is limited to 5% of the fund every quarter so it would be difficult to get out of. 

The options from the pie chart is buying call spreads on the S&P 500 to add equity beta into the mix. "Closed end funds" from the 2024 annual report was a 41% allocation to Cliffwater Enhanced Lending Fund which is another interval fund with symbol CELFX. Consumer lending and trade receivables are different forms of lending that can be private and that I expect would typically bypass basic treasury and corporate debt. 

The track record is short but the reported performance looks pretty good. I threw in the Permanent Portfolio (PRPFX) to show that with any of these sorts of illiquid investments or complex investments, there is probably a simpler and cheaper way to get a similar result. I have to assume there is an issue with how often the fund really marks to market. I asked four different AIs about this and got essentially the same answer, that the daily NAV constitutes a marking to market. 

If DNLIX still owns a lot CELFX, you might wonder why someone wouldn't buy CELFX directly. If DNLIX is subject to the same sort of limited liquidity as anyone else buying CELFX, it would be like double gating your money. It turns out the minimum is very high and the info page says you have to be an accredited investor. DNLIX isn't as restrictive so maybe someone really wanting CELFX should buy DNLIX.

When I see a chart like CELFX though, my reaction is to wonder if it is too good to be true. If somehow, something went horribly wrong, how would you get out? Getting out of DNLIX would be similarly difficult but I don't get a too good to be true vibe from that one.

Better yet from my perspective though is there's no reason not to learn about these and maybe play around with their allocation if applicable but there is probably a simpler and cheaper way to do something similar. If there isn't a way to do it simpler and cheaper, is it worth it to you to lock your money up in this way? There's no single right answer, is it worth it to you? For me it is not worth it. 

Speaking of playing around with DNLIX' allocation.

The replication is 27% S&P 500 and the rest in client/personal holding SRDAX. Standpoint is also a client/personal holding. I don't know that the CAGR for the replication should be expected to continue but the volatility and some of the other stats have a decent chances of persisting. In terms of looking forward, it would be a good idea to add some foreign equity in there and as highly as I think of SRDAX, I wouldn't even put 1/4 of 73% into the fund. 

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.

Closing Complexity

Simplify announced it is closing four ETFs including the Simplify US Equity PLUS QIS ETF (SPQ) and the Simplify Macro Strategy ETF (FIG).

Despite the firm's name, they've bundled a lot of very complex strategies into ETFs. While I have been critical of quite a few of their funds and have found a some that appear to work well, I have to tip my hat at their willingness to try a lot of very different ideas. 

QIS is short for quantitative investment strategies and Simplify has ETF QIS that is devoted to quantitative investment strategies with $97 million in AUM so SPQ combined 100% S&P 500 with a 50% overlay of the QIS fund. If you look at the QIS holdings info, I think some of the things would be recognizable like calls and puts on equity indexes and currency positions but also plenty of things that would not be recognizable unless you know what MSSIQUA1A is. Generically, quantitative investment strategies do work as differentiated return streams but I don't know if it can be packaged into an ETF. Testfol.io has the QIS ETF compounding negatively at -2.95% since its inception in July, 2023.

SPQ, the fund that combines the S&P 500 and the QIS fund has lagged far behind the S&P 500 of late. It tracked sort of closely for a while but started falling further behind late in 2024.

I threw ReturnStacked US Stocks and Managed Futures (RSST) in there because they do something similar. They both leverage up to add exposure to an alternative strategy on top of 100% equity. Maybe in a different type of market event, SPQ could have had a better run but without anything else to go on, it simply becomes a datapoint for the difficulty of bundling equities with an alternative using leverage. 

We've looked at FIG a couple of times before. It's not necessarily that it has done poorly but maybe it just hasn't done anything? 

The chart is helpful. EBSIX is a fund we use occasionally for blogging purposes and is in the macro realm. The FIG literature talks about it seeking a differentiated return stream. Eye of the beholder whether FIG has been differentiated enough to be helpful but it is much easier to make out EBSIX as being differentiated a meaningful amount of the time. The idea is not to keep up with equities, equities are the thing that goes up the most, most of the time so a differentiator like macro shouldn't be expected to keep up with equities. FIG only shows $11 million in AUM so maybe that figure and the return profile was enough for them to close it. 

It is fun to look at these types of funds when they come out and to try to track them but as another reiteration, a lot of these funds will turn out to not be very useful. Part of the story here could be that they are too complex. As interesting as these are, they are best used in small doses. A lot of simplicity (plain vanilla stocks) hedged with a little complexity.

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 Solution To Unreliable Volatility?

 The following from the CEO of Bitwise with a slight modification from me. 

Trying to improve on 60/40 is literally my hobby but the data from Charlie is not a clarion call to add more Bitcoin and crypto. Own a little, sure, why not but the solution to unreliable volatility now embedded in bonds with duration is not an asset class with even more volatility that is even less reliable. 

That brings us to a paper from Alliance Bernstein that looked favorably at portable alpha. As a reminder, portable alpha typically uses leverage to blend together plain vanilla beta with some sort of alpha (alpha being a source of outperformance). The original expression of this was stock picking added on top of indexed exposure which got hurt badly in the Financial Crisis. Lately the conversation as pivoted to using the leverage to add an alternative that might not by itself be an alpha source but when combined with beta does yield outperformance (alpha).

The paper seemed to being saying several different things about how to build a portable alpha strategy. First was " they should seek alpha in less-efficient and less-exploited market segments—such as small-cap and EM equities—where the opportunity is richer," which is obviously equity beta like they did in the financial crisis. But then "our research suggests that long/short equity strategies can be a strong alpha source, with many hedge funds outperforming even the best long-only managers." There was also talk of market neutral so the conclusion while clearly in favor or portable alpha, I don't know what they think was the best way to build it.

I wanted to play around with the long short part of their idea to look at leveraging down, not using any leverage and leveraging up.

Before using ProShares 2x S&P 500 (SSO) I looked at the 20 years one by one versus SPY and in 20 full and partial years, there were only six years, where the dispersion was greater than 1%, only two of which came in the last ten years but one of the two was the widest at 370 basis points favoring SPY. Most specifically, I compared 25% SSO/75% CASHX to 50% SPY/50% CASHX. The two should be the same and you can decide whether that is close enough but it certainly is for blogging purposes. 

The leveraged version of course was the top performer with the trade off being much more volatility and some drawdowns that were much larger than VBAIX. Interestingly the drawdown this year was only slightly worse than VBAIX. 

There are two aspects of portable alpha that are potentially interesting to me which is probably why I spend so much time on it. I have zero interest in leveraging up but the idea of getting essentially the same result while having a bunch of cash set aside, like the leveraged down version, is very effective for managing sequence of return risk. And more of an intellectual curiosity, the idea of getting a disproportionate amount of the return from a narrow slice of the portfolio fascinates me. 

Part of the Alliance Bernstein paper that seemed nonsensical was idea of picking or isolating top quartile managers for the alpha seeking portion of this. It reminded me of the old joke about wanting to get rich, ok so first go get $1 million dollars....their comments implied the exact opposite past returns not ensuring future results. 

This is fun stuff and while I believe my process has been influenced slightly, this is a very difficult path to go all in on.

Since it is sort of related, I want to touch on managed futures very quickly. The space had a great Monday in a down tape. I'm not claiming victory with that statement because this may just be one of very few good days this year mixed in with a lot of stinkers but more of a reminder that when managed futures does well, even a small weighting (which is what I have) can have a big impact on the bottom line of the portfolio. It's worth taking the time to play around with the numbers. 

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.