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. 

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