Alan Dunne wrote a fun article about The Hidden Fragility In Many Asset Allocation Plans. Admittedly there is some confirmation bias for me happening here as Dunne notes the recent unreliability of bonds for diversification and a misplaced expectation that private equity should somehow hold up well when public markets decline.
Dunne says the above is a typical asset allocation of family offices and asks rhetorically, looks diversified, doesn't it? But looked at through a different lens, the above looks more like this;
Not quite as diversified as it first appears and if we're in a period where debt can also go down in price like in 2022, it's not a very robust allocation strategy which is a point we've been making here since I don't know how long.
Similar to another another paper we looked at recently, Dunne noted that the type of diversifier matters too. It takes some sifting ability to piece together when an alternative does or does not have a lot of equity beta. A lot of equity beta is neither bad nor good, this is about expectations. For example I would expect client/personal holding BTAL to offer far more protection in the long/short category than AQR Long/Short (QLEIX). BTAL is short biased and QLEIX is long biased. One is not better than the other, they do different things.
Dunne is not a fan of small weightings to diversifiers. I think it makes far more sense and takes far less risk to diversify your diversifiers. The idea that only 3-4% in one volatile diversifier like BTAL or managed futures may not help is probably true but that doesn't mean you must have 10% in BTAL or 15% in managed futures. If 12% is optimal (12% is just an example), that could be divided between 3-4 volatile alts carried in small weightings.
Dunne doesn't say this overtly but there is a distinction between high volatility and low volatility diversifiers. Below are some low volatility diversifiers that we've talked about many times for blogging purposes.
I think these are important too as an add on to high volatility diversifiers. Other than the occasional blip, the one that did the worst in 2022 was down 3.37% that year. Echoing Dunne's point, the low volatility diversifiers do something different than high volatility diversifiers.
One of the above low vol diversifiers is a catastrophe bond mutual fund. Earlier this year the Brookmont Catastrophe Bond ETF (ILS) listed and it is struggling on a couple of different fronts. Bloomberg reported that it only has $12 million in assets and that there is also an operational issue. It launched without a lead market maker and Bloomberg did not report that the matter had been resolved, a Google search also says there is no lead market maker.
More than a few times, we've talked about the ETF wrapper not being the solution to every single strategy and perhaps that is the case with catastrophe bonds too. ETFs may not be ideally suited for full implementation of managed futures as another example as opposed managed futures replication strategies which trade far few markets than full implementation and fit very well into the ETF wrapper.
Don't dismiss an entire wrapper, like mutual funds, mutual funds are better for some strategies.
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.
1 comment:
Hey Rogers, been reading your blog for a while now, I enjoy it quite a bit. I wanted to jump in because there is something I differ from what you usually state. A 5% allocation in a diversifier will do nothing to your portfolio, unless it's really, really high volatility. In the same sense that a 20% allocation to AGG bonds in an 80/20 stocks/bonds portfolio does "nothing". What does something in this case is the 20% less that you subtract from stocks. If you really want for your diversifiers to add something, you need to make them enough space in your portfolio, and they need to be somewhat volatile. 5% to managed futures doesn't make sense. 5% to BTAL doesn't do much. If I'm going to have 80% stocks and 20% in 4 diversifiers at 5% each, I would rather own 20% cash and save the high costs associated with those alternative diversifiers, as they will do close to nothing, since most of the performance will be caused by the 20% subtract in stocks. Hope it makes sense!
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