Does It Differentiate?

A reader left a comment asking for my take on the 3Fourteen Real Asset Allocation Fund (RAA). It allocates to equities, fixed income and alternatives based on a proprietary model. The fund holds some ETFs but a lot of individual issues. We can replicate at the asset class level though.

The replication below is as of 10/29. I was going to write about this yesterday but we had a fire department call for service in the afternoon when I usually write. 

RAA just started trading earlier this year but this backtest lets us look at four years.

Of course, there's no way to give RAA credit if the process would have navigated 2022 better than the broad market. I included AQRIX because it is risk-parityish and somewhere in the literature I saw a quick reference to risk-parity.

Here's how actual RAA has done since inception. 

I threw FAPYX in because it is also risk-parity but only been around a couple of years. Without knowing how RAA was positioned earlier, it's hard to know why it lagged the replication we built. Looking at the drawdown chart, really only FAPYX seems to differentiate in any noticeable way.

If the idea is to differentiate, then it is not clear that RAA does that but in fairness it might be too soon to know. It has been a little more volatile than VBAIX or either risk parity fund and had a slightly larger drawdown. If the idea is simply to be a better mousetrap versus VBAIX then it might very well do that, it has so far. 

Portfolio 2 just has the S&P 500 and ACWX for equities, cat bonds, bank loans and plain vanilla for fixed income and I narrowed alts to just managed futures, gold and client/personal holding BTAL but it uses there allocation weightings. 

A lot of Portfolio 2's out performance came from going down a lot less in 2022 but it has also been a smoother ride. Unintended is the reiteration of how important it is to go down less during that part of the cycle. Portfolio 2 lagged by a lot in 2023 and has been nothing special in the other years except 2022 yet it came out ahead for four+ years. 

There doesn't appear to be anything obviously wrong with RAA but at this point, as noted above, I'm not sure it will differentiate. As a believer in alts, it seems plausible that it could be a slightly better mousetrap than VBAIX.

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. 

Is Good Enough, Good Enough

Mark Rzepczynski took up the issue of blending alternatives into a 60/40 portfolio. Basically, 60/40 can get it done but alternatives can improve long term results. 

I'm not sure what JP Morgan's data suggests but based on all of the blog posts we've done as well my experience using alts in client accounts, if there is a better long term result (risk adjusted or otherwise) it is because the right types of alts, used correctly should smooth out the ride and reduce drawdowns. Putting 30% in alts is very unlikely to result in a portfolio going up 25% in a year that the S&P 500 is up 20%.

Christine Benz wrote an article titled The Case For A Good Enough Portfolio that is related to Rzepczynski post. My spin on this point is having your portfolio do what you need it to do. 

That is about the last portfolio I would want, 80% VBAIX and 20% in cash. I regularly say that with an adequate savings rate, VBAIX can get the job done, I just think it is far from optimal. The nominal CAGR for that 80/20 portfolio was 6.79%. The 20% in T-bills represents a very conservative view about how to manage sequence of return risk. 95% in VBAIX, 5% in cash compounded about 90 basis points better both inflation adjusted and nominal.

As much as I dislike that portfolio, someone retiring with that portfolio at about the worst time possible (check that inception date!) is in good shape assuming a "normal" 4-ish% withdrawal rate. Through the various panics, this person wouldn't have had to worry. The portfolio was ahead of inflation with several years' worth of distributions immune to any of the big declines that occurred. So imagine a portfolio that you actually like that succeeds in smoothing out the ride. You don't have to imagine if you care to spend time looking at previous blog post studies, you can decide for yourself whether alts are additive in the manner that Rzepczynski detailed and with which I agree.

A reader mentioned that the GMO Dynamic Allocation ETF (GMOD) seems to be very similar to the GMO Benchmark Free Allocation Fund (GBMBX) that we looked at the other day. GMOD is brand new. There is certainly some overlap in the concept and some of the exposures like a tilt to Japan and more than a tilt to value but GMOD doesn't appear to use alternatives. 

Below are the holdings and weightings on the GMOD page as of Tuesday morning with one difference. I put in RSHO instead of their DRES which has only been trading a couple of weeks but they are similar enough and using RSHO let's us get a one year back test.

The results.

GBMBX seems to differentiate a little more at different points on the way to essentially the same growth rate as VBAIX and Fidelity Risk Parity (FAPYX) for the one year available to study. The GMOD replication had a lower growth rate and it's volatility landed in the middle of the four. GMOD Replication, GBMBX and FAPYX all fared better in the April panic. 

Trying to tie in both the good enough portfolio and GBMBX, I was skeptical of GBMBX, look at its since inception CAGR compared to the 80/20, the result as a core holding isn't great. That's a low CAGR for 12 years for a core holding, viewed as an alt in small weighting might be a different story though.

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. 

Is Strategy's Debt Junk?

Cullen Roche had a good blog post over the weekend that was a prompt to take a look at the Discipline Fund ETF (DSCF) that he manages. DSCF is a multi asset fund of funds that will either be 30/70 or 70/30 based on equity valuations which is inspired by how Jack Bogle managed his portfolio (didn't know that about Bogle). 

Right now, the fund is closer to 30/70. The fixed income portion is split between treasury ETFs of varying maturities. The fund started trading in late 2021 and as bad luck would have it, it immediately fell 20% +/- with the bond market so its since inception numbers don't look good but if you look from 12/2/2022, it's done pretty well. 

We just looked at a 30/70 call from Vanguard coincidentally a few weeks ago. Not surprisingly, I want no part of the volatility and interest rate risk that goes with intermediate and longer dated treasuries. We can revisit if we ever see 7% interest rates again. The idea of 30/70 is intriguing though in a 75/50 sort of way. 75/50 refers to an idea that I know from John Serrepere writing for the old Index Universe15-20 years ago. It seeks 75% of the upside with only 50% of the downside. It is hard to pull off exactly but the math is very compelling for long term results. 

I think DSCF and Portfolio 2 are a fair comparison, Portfolio 3 is of course more of a default portfolio and Portfolio 4 is pretty consistent with how we look at fixed income but to be clear I have smaller weightings to more holdings. I started the study in late 2022 to get a cleaner look, including 2022 would have disproportionately favored Portfolio 4 setting an unrealistic expectation. But if there is another serious leg up in interest rates then I would expect AGG and anything holding duration to get pasted again like they were in full year 2022. 

Portfolio 4 seems to get help from stripping out the volatility of longer dated bonds in AGG and DSCF which is why it can be sort of close to plain vanilla 60/40 in terms of growth rate but with much less volatility. 

And a couple of very quick items.

Inverse funds reverse split, that should be expected. Going to zero won't happen too often but it's not impossible. An inverse 3X AMD ETF terminated recently because the stock jumped 40% one day. If the 5X funds ever hit the market the odds of a terminating event would increase but some providers might embed some sort of safeguard. 

Strategy's convertible debt has been given a junk rating by S&P. One of their concerns is that a maturity date could coincide with a decline in Bitcoin's price. That's interesting but I'm not sure why that would be a concern unless they believe Strategy intends to sell some Bitcoin to pay bondholders. There's a lot moving parts here but I do not know why anyone would think they need these debt issues. 

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. 

Lost Decade Protection

GMO put out a paper in support of its GMO Benchmark Free Allocation Fund which has $3 billion in AUM. The fund has many symbols but I'll use GBMBX because it has a good long period to study. The premise of the paper is to isolate the periods where the basic 60/40 portfolio has had lost decades and they think we are in for another lost decade.

The paper defines 60/40 as 60% All Country World Index/40% Aggregate Bond Index. Here's the fund's asset allocation.

I took a stab at replicating it with the following.

I used client/personal holding BTAL for equity dislocation because the way the paper defined that exposure seems to be very close to what BTAL does; "100% deep value and 100% short extreme growth stocks." BTAL is long low volatility and short high volatility. The replication comes very close for as far back as GBMBX goes.

I would note that the replication has had a smoother ride and consistently smaller drawdowns but again, I think they are very close. The following chart they included led me to think they are positioning the fund as a core holding.

For the almost 13 years we can backtest the fund, the result from testfol.io doesn't corroborate the result they posted. FWIW, Portfoliovisualizer's result only going back ten years looks very similar to what we got with testfol.io. This next chart though seems to position GBMBX as an alt.

I couldn't find where this was quantified anywhere. I think that the blueish part of the charts are equities, the sort of brown part is fixed income and the purple is GBMBX but the first circle looks like hedge funds, which we can replicate, plus GBMBX. If you can sort this part out with better clarity please leave a comment. 

I'm not sure I got the above allocations correct for Portfolios 2, 3 and 4 but that's how I see them. Portfolios 2 and 4 don't have a ton of differentiation from 60/40. Portfolio 3 has a smoother ride than the others and the Sharpe Ratio suggests the compensation of the smoother ride is adequate in relation to the lower growth rate but I am less convinced. 

We've got two different lengths of time studied due to using MBXIX as a hedge fund proxy. The CAGR for GBMBX ranges from 4.77% to 5.45% and the standard deviations clock in at 6.57% and 6.63% respectively. 

This last study gets to the point I wanted to make in terms of seeking out a simpler solution. Using ACWI keeps the equity exposure and benchmarking apples to apples. Managed futures has its struggles at times and does fantastically well other times and cat bonds are one of quite a few AGG substitutes we study here and that I use for clients.

GBMBX is not trying to keep up with domestic equities. It is trying to differentiate from or help diversify a 60/40 portfolio that uses global equities. In that light, it will not keep up with domestic equities when domestic equities are doing well and they hope that GBMBX will outperform domestic equities, and their version of 60/40, when things go poorly. If things go well as they do most of the time then GBMBX might function as a diversifier but that's probably all. If there is another lost decade then GBMBX will hopefully do well.

I am intrigued by the concept of Benchmark Free and the willingness to look different, differentiation is crucial to long term investment success. I think there's something to take away in terms of process on the point of differentiation and GMO's willingness to use alts but I think a better result can be had doing it ourselves. 

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. 

Am I Diversified?

Barron's posted an article in the advisor section with advice and examples from advisors about how to diversify away from an AI bubble for anyone who is worried about that outcome. One advisor was willing to put it all on the table as follows.

April of this year is a great litmus test for diversification. The following is just the US funds mentioned by Esler so it excludes the last three listed to make it easier to read.

Not much differentiation.

That the advisor's portfolio lagged for the entire period is not the thing to focus on, it intentionally has less exposure to domestic mega cap tech so of course it lagged. The thing to notice is that when an investor would have needed to look different than simple market cap weighting it did not do so. Echoing Friday night's post, the compensation for lagging on the way up was not adequately compensated on the way down and that appears to have been the objective.

Proper diversification to protect against large market declines need some exposure to holdings that are either uncorrelated or negatively correlated to the stock market.

Next item, the Social Security cost of living adjustments for 2026 came out this week, there will be a 2.8% bump next year. My age 67 benefit as of 2026 will be $3956/mo and my age 70 benefit will be $4985/mo. If my wife takes her spousal when I am 70, she'd be 64, her benefit would be $1549/mo. 

The 2.8% seems reasonable in terms of things like groceries, gas and some utilities. The 2.8% seems totally disconnected from things like homeowners insurance, anything related to healthcare and as a personal observation, getting work done at your house. Fair enough if you disagree with me on the grocery comment. 

Social Security is an income stream. How far does your projected Social Security payout go to cover your expenses and lifestyle? The SS Administration wants us to know our numbers. If my wife and I actually get $6500/mo (that's a whole other issue), that goes an awful long way to covering our lifestyle. I made a comment the other day that the life we want costs less than what we bring in so we're extremely fortunate on that front. 

I think the easiest path to a solution if projected SS plus portfolio income isn't quite enough or if there isn't an adequate margin of safety is to create another income stream. If someone retires with $800,000 in their portfolio, that implies $32,000-$40,000 or 4-5% in sustainable income. Some sort of part time gig or side hustle that generates $25,000/yr is like adding another $500,000-$625,000 to the pot, $25,000 is 4% of $625k and 5% of $500k. Maybe SS plus the side hustle money can be enough for a short time allowing the portfolio to grow untouched. 

This is an idea I repeat frequently, it seems pretty clear that many people are going to need to add an additional income stream beyond SS and portfolio income. Even moreso if benefits get cut. Figuring this out is best done sooner than later. 

The last one is an uncomfortable article from the WSJ about tech bros and to a lesser extent finance bros in their 50s and 60's getting cosmetic surgery like eyelid stuff and full facelifts. The idea is that older dudes believe that if they look their age they will have trouble competing and staying relevant. 

Reading the article, there have been advancements in this type of treatment but the recovery periods seem very difficult and while these might be low risk procedures, the article acknowledges they are not riskless. 

It's certainly not for me to say what someone else should do but I would certainly encourage changing behaviors around diet and exercise. The odds of being perceived as competitive and relevant go up when it is clear that you can still get it done. Not having a gut of any sort (cut carbs) and clearly having some muscle mass (not even being jacked) signals that you can probably still get it done before needing to say or do anything and gives at least some credibility. From there, it needs to be earned but I can accept that the starting point is appearance. That's pretty much what the entire article is about. 

My experience with my various constituencies is probably completely irrelevant to tech bros and finance bros but the combination of having experience combined with still being able to get it done is powerful.

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. 

Friday Night Randoms

First up;

The Net Worthwhile blog had a post about how people approach and then live through their retirement. I thought the following passage was fantastic.

Boomers, on the other hand, made outearning their parents the goal (which they achieved), but too many cornered themselves into jobs they didn’t love in pursuit of a utopian retirement that often didn’t materialize.

Gen X mostly followed that plan, but younger generations have a more morbid view of retirement and are asking more of their work. Money isn’t meaningful enough for them.

Morbid view of retirement? Yikes. I can understand the idea that views about retirement are changing over concerns about the system being likely to change causing the fear that things like Social Security might change meaningfully in the next decade or two and that AI or quantum may negatively impact career trajectory. I certainly don't know what the outcome will be but anyone worried about this needs to start crafting their own solution right now. 

Another box spread fund is coming.

I'm a believer in the concept and own BOXX for clients. It's not a source of outsized "yield," it's more of a T-bill like return stream. The prospectus for XBOX says it will use broad based indexes and also ETFs. We'll see what that looks like in practice and whether it will really use ETF and whether it might differentiate from BOXX.

Barron's profiled the PIMCO Multi Sector Bond Active ETF (PYLD) which is two and half years old. It has a "6% yield without much risk." Looking at the holdings, there is a lot of mortgage debt in there currently with some very long maturity dates. The PIMCO page for the fund says the effective duration is 4.48 years despite the largest holding at 16% of the fund maturing in 2054 and a lot of other holdings of a similar maturity.

Duration of mortgages tend to shorten up considerably when rates go down because people refinance but when rates go up, duration lengthens because no one with a 5% mortgage will refinance when rates go up to 6%. The jargon for that point is convexity. PYLD is actively managed so it might look completely different if/when rates move higher but for a little mortgage backed context, MBB and VFIIX were each down mid teens  at their lowest in 2022. 

Here's a quick comparison. 

Clearly, PYLD knows what it's doing but buying a fund like this one is betting that they will continue to get it right. If risk happens fast starting on Monday, then PYLD could get hit very hard if it didn't quickly rearrange its interest rate risk. Scanning the full holdings, there are three or four very small positions out of about 500 that might be hedging interest rates but I am not sure. 

Portfolio 3 entirely avoids interest rate risk or maybe more correctly, having to be right about interest rates. Avoiding very low rates that don't adequately compensate the risk taken or accepting 7% for ten years because you think it does adequately compensate risk taken are not about trying to predict interest rates. The compensation is worth the risk or it isn't. That's a different thing. 

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. 

A Blogger Looks At Optionality & Heresy

One very long term conversation we've been having at all the various URLs where I've been writing has been marking various age or life milestones as sort of a progress check. Where I write about retirement and give input, reviewing my progress hopefully provides accountability and maybe even credibility to give that input. I've called that series A Blogger Looks At and then say whatever age like 40 or 55 and so on. Here's a link to A Blogger Looks At 59 which will link to the others in this series.

A big part of my thought process has been to frame out what could possibly go wrong and then solve the problem from there. For the last few years I've isolated 59 1/2 as an important milestone in the context of having to go Plan B in case something goes wrong at work. That is when we can take penalty free, IRA withdrawals. I hit that milestone earlier in October which led me to think about some things a little differently in terms of optionality.

A few weeks ago, Bespoke quoted Eleanor Roosevelt as saying “I am who I am today because of the choices I made yesterday.” She is talking about doing favors our future selves which we have also described as giving ourselves financial optionality and physical optionality because we cannot know what our future self might want to do. 

The financial optionality has to include living below your means which everyone has heard at some point but I think there is a better way to articulate it. The life I want to live costs less than we make. There's less sense of sacrifice with that framing. As far as physical optionality, I am always going to bang the drum of lifting weights, cutting carb and processed food consumption and next level, skipping breakfast. 

We can start to benefit from good decisions by our younger selves in our 40's, making every aspect of getting older easier. As I've said before, being in your 50's and healthy with a little bit of money in the bank is a great spot to be in especially if you are fit and able-bodied and I am optimistic that will be the case for 60's as well. 

To the extent you don't know what your future self will want to do, my wife and I had a big thing come up, we are buying a house in Tucson. We are very close to our closing date, beyond our inspection period so I think at this point, it I believe it would take something very strange for the purchase to go sideways from here. It's a small, older house on a pretty big lot, away from the downtown area, very close to Saguaro National Park. We're not leaving Walker. The house will be occasional second home use and we each have family members interested in using it too. It's insurance in case we ever get too old for the winters in Walker and if there's ever a catastrophic wildland fire in Walker, we'd have a place to go. Even without a catastrophic fire, we've had two instance of needing to evacuate for a week. Being on the fire department, I stay of course but if we get evacuated it will be much easier for my wife to go to a house that is ours instead of her parents'.

This is not something we'd thought about until recently so at 50 and 55, until very recently, I had no idea I would want to do this. A couple of good financial decisions when we were younger gave us the optionality now to do this. I think it will be a good investment but if nothing else, I think it can be a store of value against price inflation. 

I've come to have a different view on utilizing Roth and traditional IRA money which is the heresy mentioned in the title. An important point of understanding is that I don't want or plan to retire. My thoughts about not wanting to retire have not changed in more than 20 years of being an investment advisor and I am making a calculated bet that my thoughts about retiring will not change.

We are putting a lot, in percentage terms, in as a down payment and we're doing that from our joint account. I don't want a large monthly payment. Where we get into heresy is that at the original price, I was prepared to take from my Roth IRA if needed for the down payment percentage I wanted. 59 1/2 and in there for five years makes that money accessible. The final price ended up coming down a lot because the inspection revealed a lot of work that needs to get done and the seller decided to lower the price rather than get the work done herself. That made our down payment a little smaller which probably leaves enough money to fix it up and furnish it. 

I think of our situation as being coast FIRE which means that maybe you have enough saved to retire at a "normal" age but still need to work until that "normal" retirement age. You could downshift, if wanted into a lower paying job that you might enjoy more without necessarily needing to save more. We probably don't need to add to our retirement savings because I want to keep working. We plan to pay this house off quickly by diverting what I would have otherwise put into my solo 401k into paying down the mortgage instead. Maybe we can put a little more in but I think we can knock it out in four years. 

As we made our way to figuring that out, I had an interesting thought about accessing my 401k to pay for the house. The amount of tax paid on distributions would be less than the interest paid on the mortgage. A lot less. 

According to mortgagecalculator.org, a $400,000 loan for 30 years will pay $486,000 in interest at 6.375% plus the original $400,000 balance. Taking $100,000/yr from an IRA or 401k net for four years might cost $88,000 in taxes at 22% $22,000/yr or $96,000 at a 24% tax rate. For a 15 year mortgage, the interest paid would total $217,000. I would reiterate that having the option to consider this comes from good decisions about lifestyle and saving at a younger age and being old enough now to access those funds without a penalty. If we did end up pulling from my 401k for four years, we could hopefully replace that in my late 60's and into my early 70's.

We're not doing this but even considering it is a change of thought process, HERESY! The taxes, spaced out correctly, are much less than the interest. If nothing else, that is interesting to consider if you have the option. I would not suggest emptying out a 401k in this context. No debt but nothing in the bank isn't a great position to be in.

I will close by reiterating that I believe I know myself well enough to know my thoughts about continue to work will remain the same, 22 years and counting on that one, and that I believe we planned for something we could not have predicted ever wanting to do. We cannot know what our future selves will want to do. 

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. 

Swaps For The People!

Netflix got hit hard on its earning report. Here's a look at a good sampling of the Netflix ETF ecosystem from early on Wednesday.

There are no surprises which speaks to things working they way they're supposed to which is good. The move is big enough though that depending on how and when the underlying snaps back, it could lead to the 2x lagging behind what an investor might hope it would do when holding for more than one day. To be clear, the boilerplate says one day but people do hope to capture 2x for longer periods.

NFLY has become a weekly pay with the current ex-date scheduled for 10/23. This week's payout will be relatively small at $0.10 but a big decline like today combined with a distribution like last week's $0.38 could end up being a point on the chart where a big divergence happened. Wednesday's drop is also a useful example for derivative income funds not necessarily being able to soften the blow. Fair enough if a 160 basis points smaller decline does soften the blow in your opinion.

These results shouldn't change anyone's opinion good or bad about any of these. The point is just to isolate an occurrence where the common stock gets kicked in the stomach and there being no surprises in the ecosystem.

On a related note, GraniteShares had a substack post in support of the YieldBOOST MSTR ETF (MTYY). Funds in the YieldBOOST suite sell put spreads on 2x levered ETFs. Similar to the above about Netflix;

Strategy (MSTR) as it is now known is of course a levered play on Bitcoin. GraniteShares reports that the State of Maryland pension owns Strategy as a Bitcoin proxy and it's not the only one as GraniteShares reports Florida, California and others do the same. 

The table of quotes shows that MSTR functions as a leveraged proxy, not just a proxy for Bitcoin. The 2X is right where it should be on the day, the YieldMax is down a little less similar to NFLY above and MTYY seems to be down a lot less. The last price of $18.17 was stale so when I looked, the bid was only ten cents lower so still having a relatively good day. 

The idea of using MSTR as a capital efficient way to access Bitcoin is intriguing of course but relying on the relationship to be static like 2.5-1 or something else seems like a risky bet. I'm not sure whether someone made an active decision about Strategy or the uptick in Maryland's exposure came from a decision about buying QQQ of which Strategy is a small component or some other ETF that holds the stock. 

I'll close out with VolatiltiyShares having filed for even more 5X levered funds.

The idea of 10% in a 5X S&P 500 fund, 2% in a 5X gold ETF that both track their respective underlyings for more than one day and then putting the rest in a result looks like this...

...would be very compelling. We are not there with leveraged ETFs and we may never be but I would not rule out the possibility of being able to create some sort of product akin to a swap that allows for creating a 5X effect for a period defined by the retail end user. Swaps for the people! Maybe this is something that can be tokenized or otherwise created on a blockchain. 

This would be a form of leveraging down or capital efficiency. We are not there now, repeated for emphasis, but understanding these concepts now makes sense in case they become more user friendly later.

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.

Risk Assessment, Not Predictions

The Wall Street Journal had a write up about protecting portfolios against some sort of AI bubble popping. It listed out several ideas including healthcare stocks and gold. The article didn't have too much that was new but the comments were interesting. Always read the comments. 

Quite a few of the comments picked up on an element of trying to time things that usually aren't timeable. This is coincidental to a couple of different conversations I've had this week related to trying to predict things or time them. 

We've talked about this before of course but once you can change your mindset from trying to predict outcomes to isolating and then reducing exposure to risks, things become much simpler. Looking for signs of excess is a good place to isolate risks. If you spent 30 years working at Amalgamated Spats and have a lot of stock in the company, that is an excess if your shares represent some disproportionately large percentage of your portfolios. 

Derisking then becomes just that, reducing your vulnerability to an excess that you are exposed to. If 50% is in Amalgamated Spats and the stock craters for whatever reason, that would be a serious problem. It would also be an unnecessary problem. It's easy to understand that 50% in one thing is a problem without having to predict anything. 

Tech plus communications adds up to about 45% of the S&P 500. History has not been kind to sectors that have previously gotten past 30% of the index (energy in the early 80's and tech in 2000). That is an obvious risk factor. The way we phrase that here is to have no idea whether there will ever be a consequence from that risk factor but it is there nonetheless.  

There were obvious signs of excess in the financial crisis in terms of banks and real estate, ten year treasury yields at 1%  were another one, both of which we blogged about in real time. 

Are you taking withdrawals from your account to live on? If you are, having 99% in equities is a different form of excess. If there is a whoosh down that doesn't snap back like the one in April, this is a scenario that will require selling low or going without income. That seems very avoidable without having to make any sort of prediction. 

I can't say it any more plainly but instead of trying to predict anything, the idea here is to avoid obvious signs of risk or excess. 

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.

They're Here! Levered Derivative Income Funds!

Tuttle has an interesting filing for two different 1.3X levered covered call funds with the product name LIFT. One will track TSPY which is a 0dte covered call fund on the S&P 500 and the other fund being tracked is TDAQ which is a 0dte covered call fund on the NASDAQ 100.

Focusing on TSPY, this shows TSPY total return, then 1.3x TSPY total return and 1.3x TSPY price only.

Any fund that sells covered calls should not be expected to keep up with its underlying reference security on a price basis but might get close on a total return basis as the chart shows with TSPY. These are best thought of as products that combine the underlying reference security and short volatility of the underlying reference security which delivers a different outcome than just buying, in this case, SPY.

The total return of TSPY, a little bit behind SPY, is either sufficient for an end user or not. If not, then don't buy the fund. The 1.3x price only chart is not much different than the regular TSPY price only chart. The total return of 1.3x is a little more interesting if I am right about why Tuttle filed for these.

I think these are an attempt to try to get derivative income funds to track a little closer to the underlying. It doesn't look like price only at 1.3x leverage offers that opportunity so maybe these could be thought of as an attempt to try to dial this in to a smaller lag/drag. 

Let's see what happens with 1.5x TSPY which to be clear is not part of the filing.

Price return again gets left far behind and the volatility goes up. That may not be such a great combination. Leveraging up to 1.3x also shows higher volatility.

This is sort of a sifting process. Is there a path to solving some of the drawbacks of derivative income funds? There may not be but I think there is something out there, yet to be tried that would solve 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.

Work Life Balance

The Wall Street Journal had an opinion piece in August titled Work Life Balance Will Keep You Mediocre written by a remarkably driven 22 year old who wants to be a billionaire by the time he's 30. That's a gift link.

This weekend was heavy on the balance part of the equation, I worked on a prescribed fire with the forest service. I worked my ass off doing the task at hand and keeping up with firefighters in their 20's. It's a fantastic physical challenge which is part of the appeal.

Analytical Misfire

Barron's had a promisingly titled article Volatility Is Back in the Stock Market. Here’s the Zen Way to Handle It but unfortunately it was very thin. 

Here's advice from Christine Benz

Take the annual amount you’ll need to withdraw from your portfolio in retirement, multiply it by 10, and keep that amount in short-term and intermediate term high-quality bonds. Having 10 years’ worth of living expenses insulated from market movements provides peace of mind.

I don't think I've ever heard ten years worth of expenses hiding out in fixed income but ok, whatever helps someone avoid panic. I'd be more in the two-three year timeframe. Even stranger was the suggestion of using DFA Core Fixed Income ETF (DFCF) which is similar to iShares Aggregate Bond ETF (AGG). DFCF does appear to be a better mousetrap but...

...if the idea is to avoid the ups and downs of markets, why would someone want that sort of duration. Not good. 

The ETF IQ weekly letter tried to explore whether current events in the credit market related to Tricolor and First Brands might mean trouble for ETFs. It isolated the iShares Floating Rate Loan Active ETF (BRLN). It said that BRLN "has climbed nearly 30% on a total return basis over the past three years" compared to just a 16% gain for AGG implying that BRLN might be over extended. 

The 30% cumulative total return cited by Bloomberg has been all yield. If the market that BRLN has been paying 4% instead of 8% +/- then the cumulative total return would have been more like 15%. Credit more broadly could certainly be hitting some sort of snag but the analysis done in this article won't be a contributing factor. 

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.

30 Different Alts?

Jeff Malec from RCM hosted Jason Buck on a podcast to recap the recent ReturnStacked symposium that happened on October 8 in Chicago. One little funny thing before getting to the real content is that Jeff and Jason referred to them as the ReturnStacked guys which is how we refer to them.

Return stacking is a phrase they came up with to describe an older concept known as portable alpha. Thought leaders now view the way to implement it is to leverage up to add uncorrelated alternatives in pursuit of better risk adjusted returns. In decades past, portable alpha often meant just leveraging up equity exposure which went very badly during large declines. The idea of using leverage to add alternatives, they say, reduces tracking error and can help smooth out the ride. 

If you've been reading this site you might recall that I am fascinated by the concept but not a fan of the funds. 

The part of the podcast that was most interesting was their review of the presentation given by Roxton McNeal from Simplify. If you have the chance to ever hear him speak, it's time well spent. 

One of the terms relevant to ReturnStacking/portable alpha is capital efficiency. Being able to build a full 60/40 portfolio (or whatever percentages) with less than 100% of the portfolio so that uncorrelated return streams can be added is the simplest expression of capital efficiency but it is not the only expression.

Roxton talked about being able to get more diversification bang for the buck by using more volatile alts. A portfolio needs to invest less into a managed futures program that targets a 20 vol than a 10 vol. The 20 vol version will be tough to hold, it is twice as volatile, but more efficient.

The way we've looked at this concept is having some alt exposure to something like BTAL or tail risk funds which are more volatile and some exposure to unvolatile alts like merger arbitrage. I would say most, but not all, managed futures funds fall in between those two extremes. 

Also in terms of efficiency, we've looked at using BTAL to allow for having more exposure to equities which gives the opportunity for better returns but without increasing volatility. BTAL is pretty reliably negatively correlated to equities. 

The other point that Jeff and Jason hit on was Roxton's belief (paraphrasing them) that you can never have too much in uncorrelated alts. Roxton even used the word orthogonal which we use here every so often. I would say you absolutely can have too much in uncorrelated alts. Equities are the thing that goes up the most, most of the time. A portfolio of alts, hedged with a little bit of equity exposure doesn't have much chance of capturing the stock market's long term growth. 

If someone wanted 15% in alts and wanted to divvy that up into 30 different strategies (and they could manage that), fine, but the implication there is they'd still have something close to a normal allocation to equities while having a smaller sleeve, the alts, that hopefully makes the portfolio more resilient and robust to market calamities. 

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.

ETFs That Might Burn Down Entire Towns

I saw the following on Twitter.

Here's a chart looking at plain Bitcoin, those two covered call ETFs and the recent one that launched from Tuttle.

Sure, covered call ETFs could help soften the downside in a longer timeframe as distributions come in but sparing any anguish caused by a fast decline it is not an expectation I would have going in.

Did you see this filing?

That's right, 5x leverage on several individual stocks and cryptocurrencies. The more volatile the underlying with 2x, the more the volatility drag impacts return but there isn't a whole lot of predictability or reliability on how the volatility drag will effect returns but it's better to assume the effect will be negative for fund holders. All the moreso with 3x funds and 5x, man, who knows what those will do?

If you're wondering how these could possibly see the light of day, as Dave Nadig points out, there is a quirk in the filing process where these might be an attempt to take advantage of the government shutdown. 

Thanks to the ETF Rule (6c11) and recent generic listing standards, as crazy as these filings may seem, they are actually "normal," and thus, if the SEC doesn't explicitly kaibash them, they go live in 75 days.

Crazy. I make the same joke about ETFs that will melt your laptop, I think the 5x might burn down entire towns. It's not for me to paternalistically say these shouldn't be allowed to trade but if they ever see the light of day, it is a guarantee that people will misuse them and get rekt. 

Speaking of leverage, the FT isolated an issue that might be impacting some leveraged ETFs, the article hit on Tesla specifically. If you remember the few conversations we had about the night effect, apparently most of Tesla's gains come from gapping up at the start of the day and the FT says that is a complicating factor for the levered funds that have a daily objective/reset. 

The 2x levered S&P 500 seems to avoid many of the obstacles that challenge the entire levered ETP concept but even then, they are not infallible. These really are the underlying plus the volatility of the underlying and there's more than just an element of they're whipping around like an unmanned fire hose. 

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.

Is There Such A Thing As A Tax-Less Portfolio

Let's look at a couple of quick theoretical portfolio ideas. Not sure where this first one came from but it's interesting.

It's quadrant-inspired to some degree with 30% in precious metals, 25% in equities, 40% in very low vol, specialized fixed income and 5% selling volatility. It's been less volatile with smaller drawdowns which is good. You can see periods where it has lagged, then caught up and recently pulled away. In 2022 it outperformed by about 11 percentage points, going down much less. 

I asked Copilot to back test the idea from 2010-2020. I used client/personal holding Merger Fund instead of cat bonds and I just said selling OTM S&P 500 puts to replicate WTPI.

In the same period, VBAIX compounded at 10.2% with volatility of 10.26% and a max drawdown of 22.77%. I wanted to isolate the 2010's because it wasn't a great time for precious metals returns. 

Something I haven't needed to manage much in my practice is clients with taxable accounts who are in the 37% tax bracket. I've been doing some subadvising for an advisor who most of his clients are taxable accounts in that tax bracket. In trying to think about portfolio construction, of course the conversation includes "what about AGG or BND" which both track the benchmark Aggregate Index.

From inception in 2004 through to year end 2021, so excluding the regime change that started in 2022, AGG's compounded total return was 3.82% and the price only compounded return was 59 basis points per testfol.io. So the vast majority of the return has been from the yield. Yield that is taxed as ordinary income. Thinking this through, the yield, less the taxes, less the rate of price inflation and there's not much left over. I've never used AGG or BND so this is an interesting way to think about them. 

A high income-tax-bracket investor probably should not have a core position in a fund like this. I do want to make one distinction. I am saying a 60/40 portfolio shouldn't put 40% into these. I could see where weaving in a slice of one of them because it creates some sort of desired outcome when blended with other income market exposures is a very different thing. Just because I don't use AGG or BND that way doesn't mean there are ways to do that. 

Someone recently said to me, if you see a problem, it would be nice to offer a solution and the ETF market does have a solution. 

The backtest is short due to the inception date of client holding BOXX. BOXX has no yield (it paid 1/4 of 1% last year in capital gains) and BALT has not paid any distributions. BOXX and BALT are not without their flaws and where there are these two dividend-less funds with very low volatility, there must be others. The yield in the portfolio we hope is more tax efficient comes from the S&P 500. This past summer the Roundhill S&P 500 No Dividend ETF (XDIV) started trading and as you can see by the name it will avoid paying dividends. It's too soon to draw any conclusion about that fund but so far, no catastrophes.

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.

Solving For Y

Think Advisor posted about a 50/30/20 portfolio where the 20% is annuities. The annuity aspect of it doesn't interest me but it's a good prompt to dig a little deeper on an idea we've explored before related to drawdown strategies for a finite period like maybe trying to make a piece of money last until taking Social Security at the desired age or maybe until RMDs start. The RMD angle presumes the IRA in question is the primary account and maybe the drawdown strategy comes out of a smaller taxable account. There could be many other scenarios though where this theory could fit.

LifeX has a suite of funds that tie into the idea of a drawdown strategy. For this post I'm going to use the LifeX 2035 Income Bucket ETF (LDDR) which as the name implies runs for ten years. At this point, I don't know if next year they will come out with a 2036 version or what their future plans are but I would bet there will be more of these regardless of whether they come from LifeX or other providers. 

With a ten year window from LDDR, maybe this person is 60, retired and wants to take Social Security at 70 or maybe they are 65 and hope this piece of money lasts until RMDs at 75.

I chose $400,000 in this smaller, maybe taxable account versus an IRA that is sufficient for whenever it needs to be tapped. If this person can holdout anywhere close to ten years, then the IRA has the opportunity to grow significantly. 

The weightings  used above are just a slight tweak on 50/30/20. There is barely any income these days from the S&P 500, just over 1%. Client/personal holding EMPIX has paid $0.62 so far this year. As of Jan 6 which is the start date for LDDR, $120,000's worth of EMPIX would have paid a total so far of $7359 which might extrapolate out to $8866. NFLY has paid $6 in distributions so far this year so $20,000's worth at the start of the year would have been 1100 shares good for $6600 of income for the first 10 months of the year. It may not extrapolate this way but for the full year it could be $7951. The $80,000 to LDDR. per the LifeX website, is going to distribute $9373/yr on the way to depleting in 2035. VOO now yields about 1.15% so $2700 there. 

So with this weighting scheme we get the $400,000 paying an income of $28,944 with only 25% in holdings that should be expected to deplete, LDDR and NFLY. If that figure, combined with any other income streams isn't enough, it would probably make sense to take from the 45% we put in equities. 

In terms of trying to plan out what the equities will bring to the table, if over the next ten years the equity exposure compounds at 7%, lower than usual, then whatever amount was allocated to equities (10% or 45% or something else) would have grown in value by 96% total. The scenario might be able to get away with just 30% in equities and put that extra 15% into the yield or depletion sleeves of the portfolio which might add an additional $6000-$7000 of income on top of the $28,944 (less whatever dividends are given up by reducing VOO exposure). 

Sticking with our example, putting the entire $400,000 into LDDR seems unnecessary. We've constructed a plausible scenario that assumes below trend equity growth that could have close to $350,000 remaining in ten years (assumes the 30% in VOO grows to $235,000 and the EMPIX just treads water). And again, the weightings could be tweaked even further of course to increase the income potential.

Yes, it would not be too difficult to do what LDDR does and save the 25 basis point fee and we are assuming LDDR will do what it is supposed to. IRL, 30% in to one specialized income fund is a very bad idea, it would need to be spread out. I would not be afraid of 5% in crazy high yielders though with the expectation and understanding that they are going to erode significantly. That's ok in this scenario. The reason I use NFLY in these posts is it is not the most volatile one in the product line and it avoids crazy CEO risk. 

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.