Derivative Income Disaster

Today's ETF disaster comes from Coinbase. Disaster might be too strong of a word but below is the GraniteShares Coinbase Yield BOOST ETF (COYY) and the underlying common. 

It may not be as bad as it seems. It is a weekly pay and so far, all the distributions add up to $8.75 which is a little better than a 33% "yield" from the August price in about three months. It should be pointed out that the distributions have also been trending lower along with the share price. On a total return basis, COYY is only a couple of percentage points behind the common. 

This chart compares the Nvidia Yield BOOST and the common.

The common up huge for just a few months and the price only chart for NVYY is still down double digits. It's not that these are malfunctioning in any way, I don't think they are, the point is how difficult these probably are to hold. I do think that as part of some sort of draw down strategy, a small slice can be useful with the right expectation. These are going to erode down to almost zero and then reverse split. Growth from the part of the portfolio that is some sort of normal equity exposure should more than offset any erosion from a very small slice someone allocates to a crazy high yielder. That will probably not be compelling to too many investors though.

Calamos is coming out with another autocallable ETF that will have symbol CAIQ and be tied to the NASDAQ. Eric Balchunas Tweeted that it will target a distribution rate of 18%. 

These are billed as not having a problem with erosion like the crazy high yielders. Looking at the chart I would say erosion has in fact not been an issue for CAIE but even if you agree with me on that, I would not say the science is yet settled on this point. 

The product in the ETF wrapper is a democratization of a a structured product that is usually only available to institutions. CAIE's distributions would be disrupted by a 40% decline the the S&P 500. I couldn't find the similar pivot point for CAIQ but some sort of hideous decline in the NASDAQ and CAIQ's distributions would be suspended too. 

I don't think the risk is so much a decline of the magnitude that would cause distributions to suspended because of how rare they are. It is not clear to me whether the market price of the ETF might deviate from the NAV of the autocallables held by the funds if the underlying index fell 25%. Assuming no malfunction or something breaking, a 20% decline for the reference index doesn't impact the underlying holdings, the actual autocallables. 

A key point in that last paragraph; "assuming no malfunction or something breaking." Anything that yields 14% like CAIE or 18% like CAIQ in a 4% world carries risk. Maybe you can figure the risk out and then you can make an informed decision as to whether the compensation is adequate for the risk taken. It is difficult for me at this point to think the only risk that the index falls 40% in a short period of time and that's it. 

A small slice to an autocallable ETF wouldn't be ruinous if it malfunctioned. There are several unrelated niches that have very high yields and could be added to a diversified portfolio to meaningfully enhance the yield. A meltdown in the autocallable market would have nothing to do with catastrophe bonds or a bank loan 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.

The Catastrophic Side Of 2X ETFs

How it started.

How it's going.

This general sort of catastrophic anecdote has repeated over and over forever and will continue on into the future forever. 

The modern version of 60/40? Simplify has some thoughts. 

The link talks about actively managed bonds and suggests their AGGH to fill that role. AGGH owns a whole lot of AGG with a treasury options overlay to generate extra income, 7.52% versus 3.81% for AGG. 

The data goes back to AGGH's inception on Feb 15, 2022. Yes the total return has exceeded AGG cumulatively and in all four full and partial years but not reinvesting the distributions makes for a tough hold. The idea of a 60/20/10 actively managed fixed income/10 alternatives that go a little broader than just managed futures can probably be structured to be very robust but 20% AGG plus 10% AGGH is very close to 30% AGG and would not be robust in the face of another big move up in interest rates.

Portfolio 1 is their idea but using DBMF instead of CTA to go back just a little further in 2022. Portfolio 2 is their idea using funds we talk about here very regularly, FLOT and BKLN are client holdings.

The max drawdown for Portfolio 2 occurred in April of this year, it didn't really offer the protection it did in 2022 as you can see below.

Yesterday, I mentioned a Twitter thread from Meb Faber about single ticker portfolios. Left off of Meb's list was Cambria's own Trinity ETF (TRTY) that someone else mentioned in the comments. We've looked at this fund a couple of times and over its seven+ years, it has struggled cumulatively but it has had a couple of very strong years in there. Testfol.io has TRTY compounding at 4.94% versus 3.58% for price inflation. 

Here's the year by year.

In four years (2019, 2020, 2023, 2024) it got left way behind 60/40 as measured by VBAIX. 

TRTY allocates 35% to trend, 25% to equities, 25% to fixed income and 15% to alternatives. If you look at the current holdings, it's not so easy or obvious to see how some things are categorized. For example, it has a position in the Cambria Tactical Yield ETF (TYLD) which flips between T-bills and other fixed income market sectors based on how wide or narrow yield spreads are. Based on the chart, I believe it has been in T-bills only, since it started trading. You could argue, that's a form of trend as opposed to fixed income. What about an equity ETF that tracks the momentum factor? Arguably that is trend too. 

Looking back, it doesn't look so hot but if there's a reason to be optimistic, I could see where TRTY benefits from the evolution of ETFs, TRTY is a fund of funds. Cambria are smart guys and it seems like a reasonable probability that TRTY can enhance the long term result finding better ways to build out their allocation that includes 35% in trend and 15% in other alts.

The following is similar to what we've looked at before in trying to understand TRTY.

I certainly don't know what if any constraints Cambria has for what funds go into TRTY but as is frequently the case, the allocation strategy works, taking their idea for Portfolio 2, with funds we regularly use here and the result looks good. 

This is another example of taking bits of process from various sources to create your own process.

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.

Can A Single Ticker Portfolio Be The Answer?

The following chart comes from Todd Sohn at Strategas.

Dabble if you must, but most of this is air. Bitcoin might even be air. I don't think it is but there's no way to know. Meanwhile, as the chart shows, there has been an absolute explosion in the number of products tracking alt coins that many people haven't heard of, like HBAR (there's an ETF for it, the full name is Hedara). I am including levered versions and derivative income versions too. 

There is asymmetric potential for some of these...I guess, and I continue to hold Bitcoin for this reason. I mentioned selling some for the down payment on our Tucson house and that I had bought back about half what I had sold. I sold at $115,000 on the way up to $126,000. I bought a little back at $115,000, some at $111,000 and early on Tuesday I bought a little more at $91,000. The purchase today is inline with an idea I've talked about before. I have no idea whether $91,000 will be any type of bottom (it's at $95,000 as I write this post), that wasn't even my thought process. I bought a little after a 27% drop. That is buying low, even if it goes lower. Even if this one doesn't work out as being a good purchase in hindsight, buying assets after a large decline will turn out to be a good entry point more often than not. 

Meb Faber tweeted out that there is $700 billion in mutual funds like VBAIX that are intended to be "single ticker portfolios" versus just $20 billion in single ticker portfolio ETFs. The mutual funds are pound for pound more expensive and less efficient tax-wise. 

Meb included these tickers but it is not an exhaustive list. AOA, AOK, AOM, AOR, AVMA, CGBL, DDX, DSCF, ELM, GAL, GMOD, INCM, IYLD, NTSX, PBL, RSSB, TBFC, TBFG if you want to check them out.

Dave Nadig replied "Advisors hate single ticker portfolios. Individual investors only find them after they've had their hands burned market timing. Give it time...." These types of funds are absolutely valid as we've said many times before but they have drawbacks. You have to want the sort of bond exposure that they have and often that is AGG-like exposure. After 2022, I believe you need to think long hard about that sort of allocation with any kind of meaningful percentage. A small slice to AGG as part of a diversified strategy, ehhh, ok I guess but 40%, if interest rates have another meaningful move higher, these fund will get hit. 

Looking at AOR, AOK and IYLD, there were all down mid teens in 2022 when bonds with any sort of duration went down in price in a similar fashion to equities. The point is just to understand the drawbacks. 

Here's an article that looks at active versus passive portfolio management with work by William Sharpe as the starting point for the conversation. The article disagrees with Sharpe for being overly academic and theoretical, my words not theirs. My usual refrain is that there are many managers running very active strategies with passive products and this research never accounts for that. It's possible there's no way to fully account for it.

Not all active has to involve a lot of trading and repositioning. I have quite a few holdings for clients that have been in there for 15-20 years. An important point I would reiterate on this topic from previous posts, is that sometimes the most important decisions center on what to get out of or otherwise underweight. Sidestepping ground zero for some sort of future calamity or maybe just underweighting it and doing nothing else could add a lot of basis points to long term results. Think tech in 2000 (before I was a portfolio manager, I was a trader back then), financials in 2007 and bonds with duration in late 2021.

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.

Diversify And Chill Part 2

On Sunday we looked at a simple diversification of 1/3 each in the S&P 500, gold and emerging market equities. Then in another version we sprinkled in a little managed futures. Today, let's take a little more of a quadrant inspired mix of 25% each into those four.

First, here's as far back as we can go, which is a good long time. Note that I used VBINX for 60/40. It's the retail version of VBAIX that we usually use and it goes back just a little further. 

The 31/31/31/7 blend is a holdover from Sunday. The period studied includes plenty of good times and bad times for the four asset classes in the two versions on the simple diversification. 

Here's just the lost decade for stocks ending 12/31/2009.

The two versions of the simple diversification did ok during the internet bubble and a little better during the financial crisis but the overall growth rate was good or maybe better described as normal when considered against the S&P 500. A CAGR of 8-9% and you'd never know it was a lost decade.

The 2010's were weak for gold, managed futures and emerging all compounded in the threes.

Not a lost decade but certainly weak in the context of the Peter Oppenheimer article that was the prompt for these posts. For the 2010's, price inflation ran at 1.75% so still a decent real return and very little distributable income for anyone wondering about taxes. I actually think compounding above 6% with three of the four muddling along is pretty good.

Finally, the 2020's.

Of course nothing was going to keep up with the S&P 500. No surprise that both versions of the simple diversification held up much better in 2022. Despite having no bonds, the equal weight version had very similar volatility to VBINX in all periods studied. That piece of the result is about blending together assets with low to negative correlation as captured by Portfoliovisualizer.

Diversification can be simple but as we saw, there could be long periods that demand patience. 

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.

Diversify And Chill

We're going to go all over the place with this one. 

First a a couple of quick hits starting with concierge medicine in Barron's. I don't have a ton to say about it. It's expensive but if someone needs to engage kind of frequently with the healthcare system and can afford it, then sure, why not? There was a comparison to concierge medicine being like old time medical care from you small town doctor which is interesting. 

This quote was right up my alley, "patients are typically screened for grip strength and gait speed, metrics of well-being that insurers typically don’t cover." I don't know about those things being covered or not but grip strength and retaining the ability to walk fast are very telling benchmarks. This is where I say to lift weights (deadlift, squat, farmer's carry, landmine twists) and get out and climb some hills. 

The Streetwise column took a look at what's going on at Robinhood in terms of offering prediction markets (betting) along side crypto and more traditional stocks/bond/funds. I think this is a positive step for the long term. I have zero interest or intention of speculating on who scores the first touchdown in the Patriot's game or whether Sarkozy ends up staying in prison or not but this can be a bridge to doing more things inside the typical brokerage account as we now know them. Different types of assets will at some point be tokenized to provide access to different types of assets for investors. 

Art and collectibles come to mind in this context but there must be others. These types of assets tend to be uncorrelated, I say tend but that is not always the case. I told this story once before but early on in the pandemic I bought a 1970 Bobby Orr hockey card for $20 that has a 6.5 grade. A year or two ago when I looked, there was a 6.5 for sale on eBay for about $300. Sure the return is great but aside from having no idea it would go up like that, even if I somehow knew, there's no way to buy 1000 of them for a portfolio allocation. Tokenizing either a collection or some very expensive card would be a way to allocate to an asset class, collectibles in this example, that is not easily accessible. That is a positive but there will probably be bumps and bruises along the way.

Peter Oppenheimer of Goldman Sachs is expecting a weak decade ahead for domestic equities versus other markets. Not a lost decade though, he thinks the US will compound at 6.5%. If he's right about relatively weak returns and the 6.5% part of the guess, that doesn't sound so bad to me. 

The real lost decade we had is captured below.

You can plug in your own dates to play around with it but you can the S&P 500 compounded at a negative 82 basis points. Despite that average, there were of course a few big years in both directions. You can see that emerging markets, as measured by VEIEX, and gold did just fine and blending all three together compounded at 8.7% despite the lost decade for domestic equities. 

If the US ever does have another stinker of a decade, there will be markets and asset classes that will go up. If you don't want to guess what those might be, then there's your argument for broad diversification. 

Testfol.io has simulated DBMF and KMLM which are both managed futures funds. While there should be a grain of salt with this, simulated DBMF compounded at 8.44% in that period while simulated KMLM checked in with 12.06%. Again, grain of salt but I do feel comfortable taking them as being indicative of managed futures doing relatively well even if the exact numbers they came up with need some faith. Other forms of long/short could probably also do well under Oppenheimer's scenario. 

I am a big believer in defense industry stocks and in the period studied, client holding Northrop, Lockheed and General Dynamics compounded at 9%, 12% and 15% respectively. While there's no way to know whether they would again do well despite a weak or lost decade, if anything the demand in this niche is greater now than it was 25 years ago. 

As opposed to lamenting this sort of prediction or outcome, I would think of it instead as a challenge to overcome. Putting it very simply and sort of repeating for emphasis, we had a lost decade not that long ago and the thing that worked was simple, broad diversification. Looking back at the last few years, simple, broad diversification might have caused some frustration at times, over the long term, it of course works. 

Maybe not that frustrating. The second backtest has the same start date, running through to this week. Broad diversification again worked. 

Diversify and chill.

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 Volatility Harvesting

Dave Nadig reports shot fired by SPDR at JP Morgan.

SPIN is a new one to me and sort of new, it started in early 2024 and oddly for a SPDR ETF it only has $61 million in AUM. SPIN picks individual stocks and sells index calls as does JEPI.

SPIN has had the upper hand since it launched but JEPI has had strong years along the way too. Anyone who believes JEPI is great is simply enduring a relatively weak period. At some point SPIN will do likewise. Even if SPIN is great or turns out to be generally better than JEPI it will have periods where it does poorly. Using funds that sell volatility as anything beyond a small diversifier at the margin is a tough way to make a living. 

But as a small diversifier, I am a believer that there are ways to sell volatility even if the most popular way, the single stock covered call ETFs is a very flawed way to do it. I've talked about client/personal holding PPFIX as a very low leverage way to sell volatility, the other day we looked at OCTH and OCTJ in the same context but they're a little more volatile (Innovator has other funds running the same strategy with different reset months).

Mathew Tuttle hosted a webinar on Friday titled Covered Call ETFs Suck. YieldMAX took a beating in the webinar.

The chart compares the price only return of the Tesla YieldMAX and the Netflix YieldMAX. It shows a point we've touched on here but that Tuttle seemed to really hit on which is that selling calls on very volatile stocks in the manner that the ETFs do isn't a great trade. The more volatile, the worse it will probably be as seen in the Tesla/Netflix comparison. 

Tuttle's firm is working on some interesting things. They have a "no bleed" tail risk fund coming that I may have mentioned before and they are working on a fund that would be 100% S&P 500 and 100% their tail risk strategy. The other idea is ETFs that sell put spreads on individual stocks. Selling put spreads is bullish and of course would be a derivative income strategy. Again, as a small diversifier at the margin, this might be interesting. 

We spend a lot of time studying volatility as an asset class and a strategy because I think it is an important diversifier but there are probably more ways to use it incorrectly than correctly. 

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.

Does AQR Read Random Roger?

No they don't but their latest paper ties in with our approach here very, very closely. The title is Diversifying Alternatives and the Rearview Mirror and the paper looks at how to use alternatives, how they can help smooth out the ride and what the emotional challenges of holding them can be. 

From the summary:

Diversifying alternatives—investment strategies whose gains and losses occur at different times to those of major markets—are beloved by portfolio optimizers seeking to maximize risk-adjusted returns. But for human investors, it’s more of a love/hate relationship. Stock markets go up most of the time, which means that diversifiers are often likely to feel like a drag on returns—even if they improve long-term wealth accumulation.

It's almost the identical way we phrase these ideas here. This is why I say to have an equity-centric portfolio hedged with a little alternative exposure not the other way around. Client and personal holding BTAL is a remarkably reliable first responder defensive which means it is going to be down most of the time. On Thursday, with the S&P 500 down 1.66%, BTAL was up 3.25%. You never want BTAL to be you're best performer, there have been several times since I first bought it where it has been the best performer and that was because the market was in some sort of nasty drawdown. 

The paper looks at various types of long/short strategies of which BTAL is one, BTAL is short biased. Any sort of arbitrage is long/short, you could argue that managed futures is long/short too and of course long biased like AQR Long Short (QLEIX). I don't use any long biased long/short. 

They talk a little about hedge funds and include this chart.

The weighting of the combo wasn't quantified but the effect captured in the chart makes the same point that we do all time about smoothing out the ride. Our blog backtests, and what I do in client accounts don't involve actual hedge funds but a similar effect can be introduced with mutual funds and ETFs. Look at 2004/05 in the chart. The combo lagged badly for that short stretch the but long term has been much smoother with far less violence during big drawdowns. 

The part on myopic loss aversion is pretty important. It also delves into line item risk. The basic of myopic loss aversion is losses hurting more than gains feel good. It can be a little trickier with line item risk. I don't know who first said it but "if they all go up together then they're all going to do down together." What matters is the bottom line number of the portfolio. Is that bottom line number doing what you intend it to do. 

If someone decides to put 100% into a single tech sector ETF they probably are expecting it to go up a lot more than the S&P 500 which it probably will do with the understanding that the drawdowns will be much worse. We looked at Amazon in this context the other day. The upside has been phenomenal and declines have been enormous. That's not likely to change. 

So a portfolio that needs to be diversified, not all of them do, probably owns a few things that do a lot of the heavy growth lifting and a few things that one way or another help with that volatility like how some people use bonds or maybe consumer staples stocks. It won't be too often that your laundry detergent stock will be up 30% when the index is up 15% but your tech fund very well could be. And if you use believe in diversifiers in the context we talk about here or from the AQR paper, then the right expectation is that the thing that protects against the bad kind of stock market volatility is going to look different than the stock market, maybe a lot different. 

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.

What Is Total Portfolio Approach?

Have you read anything about 'total portfolio approach' that institutions including CalPERS are starting to adopt? Here's a paper from the Thinking Ahead Institute that dives in too. It's pretty nebulous (so far). Copilot suggested the following "reference portfolio" to make up 35% of the portfolio;

• 40% Global equities
• 30% Global bonds
• 30% Inflation linked securities/real assets

And for the "completion portfolio" 65% divided as follows;

• 15% Private equity/venture
• 10% Thematic public equities
• 10% Opportunistic credit
• 5% Trend following/managed futures
• 5% Equity long/short or volatility arbitrage
• 5% Tail risk or macro hedge
• 5% Multi factor equity
• 5% Alternative risk premia 
• 5% Cash or T-bills

Here's how I built it out in the exact order listed above.

We usually use BX as a proxy for private equity but 15% is too much and PSP reduces the favorable skew that BX adds.

The back test is of course compelling but it's a portfolio that requires patience. Of the six full and partial years available to study, it lagged in four of them but to be fair, two of the years it lagged it was by only 3 basis points both times. 

It's certainly not a simple portfolio however. I think it can be simplified. 

Still not that simple but simpler with the biggest change probably that we took out the fixed income duration.

Sticking with domestic factor rotation with DYNF means it probably means it would lag if foreign equities go on a long run of outperformance. 

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.

Protecting Against Mag 7 Upheaval?

Here's an interesting one they talked about ETF IQ this week, the Tema S&P 500 Historical Weight ETF (DSPY). What that means is allocates to current constituents based on its "average monthly weighting since December 29, 1989."

The effect of that process is DSPY is less concentrated than the S&P 500. The Invesco Equal Weight S&P 500 ETF (RSP) came up in the conversation, the Tema CEO quipped, do you really want Campbell Soup to have the same weighting in your portfolio as Nvidia? I thought that was funny.

Here's a comparison between DSPY and one of the S&P 500 ETFs.

There's clearly differentiation there. 

Not surprisingly, DSPY has lagged, it has less of the group of stocks that have been leading (carrying?) the broad market. I am surprised that DSPY didn't do slightly better during the April panic. SPXT is the S&P 500 excluding technology.

With less exposure to the Mag 7 and the rest of Big Tech, I would assume DSPY to be less volatile but only slightly so from testfol.io.

This is an interesting idea so the question is will underweighting the Mag 7 and the rest of Big Tech work if there is some sort of upheaval in the AI space. 

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.

What Risks Should You Avoid?

I stumbled into a couple of new (to me) ETFs. Innovator who might be most known for BALT and more generally buffer ETFs actually has 157 funds with $29 billion in AUM, I didn't realize they were that big. 

The mindset for this post is funds that use equity stuff to create an intended outcome that looks nothing like the equity market. BALT is long a call spread on the S&P 500 and a put spread such that the outcome, the intended outcome is a horizontal line that tilts upward. When the S&P 500 is up, BALT lags, and in 2022 when the S&P 500 was down 18%, BALT was up 2.45%. It is not a proxy for equities. There is a sensitivity to large equity declines though. If the S&P 500 drops by 20% in one calendar quarter, BALT should be expect to feel any further decline beyond 20%. Back in the April panic, the S&P 500 didn't quite fall 20% but BALT did wobble a little bit with a fast 5% decline that was recovered quickly. 

I do not know about too many of Innovator's funds so hopefully I can learn but I did stumble into a couple that do something similar to client/personal holding Princeton Premium Income Fund (PPFIX). PPFIX sells S&P 500 Index puts that are very far out of the money. There's a little more nuance than that but the effect is that PPFIX also looks like a horizontal line that tilts upward. It uses equity index derivatives to create an effect that is not intended to look like an equity index. 

The two funds I want to mention are the Innovator Premium Income 20 Barrier ETF (OCTH) and the Innovator Premium Income 30 Barrier ETF (OCTJ). The high level description for these is that they are short out of the money S&P 500 put spreads along with another short position in puts that is not spread off as well as owning T-bills. OCTH protects up to a 20% decline like BALT and OCTJ protects up to a 30% decline. 

BALT doesn't have distributions, OCTH yields about 7% and OCTJ yields about 6%. It looks like the distributions are characterized as ordinary income. It is important to note that there is a lot of complexity to these that would take far too long to explain here. Anyone interested in these for real should learn those complexities. 

Here's how they did in the April panic. 

In certain fast declines, PPFIX sometimes has to mark their positions to market in such a way where the NAV can drop more than expected, only to bounce back a day or two later. Is seems plausible that OCTH and OCTJ have to do something similar.

All five of the portfolios are 60% in the S&P 500. The backtest doesn't go far enough to look at 2022 but where BALT and PPFIX did much better than AGG in 2022, I would guess that the strategy underlying OCTH and OCTJ would have also held up better for not taking interest rate risk.

There's not much differentiation between the five portfolios and that is the point. Getting the fixed income effect without taking on interest rate risk. Allocating 40% to a strategy that sells volatility, even vol that is very far out of the money, is a very bad idea. The way to use something like this, is in a small slice as a differentiated return stream from other fixed income proxies also used in small slices. 

A fund that sells volatility in this manner would take on different risks than some sort of arbitrage or some sort of credit risk. Catastrophe bonds have their own unique risk factors. Some sort of blending of different risk factors only to get a very similar result to AGG is not a bad outcome. If AGG never has another down year again, underweighting it avoiding it still avoids the risk is poses. I choose to avoid its 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.

Because Bitcoin Doesn't Have Enough Volatility

The Wall Street Journal wrote about the "crumbling" of the Bitcoin treasury trade that companies like Strategy (MSTR) are involved with. If it's crumbling it's because Bitcoin's price has taken a hit lately, along with Ether (there are Ether treasury companies too). 

Here's the last three months for Bitcoin, Strategy common stock and the Strategy ETF ecosystem.

But as you can see below, when things go well, they go very well.

Sort of. The prices in the second chart are obviously up a ton, taking advantage of the upward volatility but the tracking is all over the place with no reasonable reliability between the different proxies. 

Brent Donnelly is quoted in the article as saying you're paying $2 for $1's worth of crypto, it makes no sense. I believe that at one point, MSTR's leverage on Bitcoin was up to 4-1 but has since come down from there. If you know differently about the 4-1 leverage please leave a comment. 

I think I've been consistent about Bitcoin, believing in the asymmetric opportunity even if not being a true believer in Bitcoin. I've owned it a long time and the payoff so far as been asymmetrical. Part of my sentiment is that after having spent a lot of time trying to learn about it, it would be hard to then watch it go to a bazillion without me. To the comments on the WSJ article, I probably fall into the speculator camp where Bitcoin is concerned. 

Bitcoin had probably grown to about 5-6% of our investible assets before I sold a little to put toward the down payment on the Tucson house. I added some of what I sold back into our various qualified accounts but not all of it. 

Trying to engage in all of this via the embedded extra leverage of Strategy or other Bitcoin treasuries seems like a very difficult way to make a living. Bitcoin's volatility has scaled back some since the ETFs started trading in early 2024. Pre-ETF, Testfol.io has Bitcoin's volatility at 103%. Since then it runs at 50% which is still a very high number. Strategy's volatility is now 96% so it is sort of what Bitcoin used to be and MSTU's volatility is 173%.

Being a market participant may not be easy but it doesn't have to be as difficult as trying to gamble on Bitcoin treasury companies. There's a lot more that can go wrong beyond the price of Bitcoin falling. 

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.

Don't Get Done In By Panic Selling

Could I interest you in a 7,195% return over 25.5 years? Skeptical? I will sweeten the pot. The day you bought, it then went on to drop 80% over the next couple of years. I am talking about Amazon. From it's internet bubble high, it dropped 80%. Then, during the Financial Crisis it fell 63%.

Here's an excerpt of the letter that Jeff Bezos sent to shareholders when it was down 80%. 

You can click through the above link to read the entire thing.

I can't say that I would have held on through an 80% decline, I don't know. What about a 63% decline when the S&P 500 was down 55% at its worst? In late 2008, one of the few purchases I made was XLY which has been heavy in Amazon since long before the Financial Crisis so maybe I'd have held AMZN down 63% in that scenario. FWIW, I did not sell tech which is something of a cousin to Amazon. 

The point to take away from the huge declines in Amazon stock is to maybe no freak out when a stock drops 20%.

The blue line is a stock I have owned for clients back to when I first started at YourSource Financial in 2004. The cumulative return has been 1797% versus 789% for the S&P 500 per Testfol.io. I did shave the position down once or twice along the way.

Look at the drawdown chart. It did worse in almost every drawdown over the last 21 1/2 years. Almost every one! It only lagged the S&P 500 in six individual years but the years it did lag were brutal. In 2018 it was down 19% versus down 4.5% for the S&P 500. In 2023 it was down 12% versus a gain of 26% for the S&P.

No one can get them all correct but if you put in some effort to understand the companies you own, the odds of making a panicked mistake go down.

Anyone using sector funds or thematic funds, an entire sector isn't going to zero. There's no broad based index like the S&P 500 or the Russell 2000 that is going to go to zero. Something I've been saying for many years is that there no question that the S&P 500 will hit 2x whatever the price level is today. The questions are how long will it take and might it go down 40% before hitting 2x the price level is today. Once you really accept that, navigating declines becomes easier.

I'm not a huge fan of doing a lot of selling to get defensive. I think it makes more sense to increase exposure to negatively correlated assets. That approach removes guess work. Oh, you just sold yesterday? What if that was the bottom? 

I am differentiating selling a stock where something related to the company changes, that's different. This post is about not panicking when the broad market gets hit. 

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.

"Things I Think I Think"

There's an idea that if you can't argue the other side of what you believe, that you don't really understand what you think you believe. As a dumb example, I am a lifelong Celtics fan. Are the Celtics the greatest team ever or is it the Lakers? I think I can make the argument for the Lakers despite believing the Celtics are the greatest team of all time. 

Sort of related, Cullen Roche regularly blogs 3 Things I Think I Think which is an outlet for him to challenge his beliefs. 

On Friday, I listened to the Trillions podcast. Matt Kaufman from Calamos was the guest and the primary topic was the Calamos Autocallable ETF (CAIE). I wrote about CAIE a couple of times and those posts were some combo of being skeptical and negative. So far though, the fund has done very well. Despite paying out just over 1%/mo, the price has mostly kept up with the S&P 500. 

The product is complex. Listen to the podcast to hear Matt explain things but basically, the S&P 500, as the underlying reference security would need to fall 40% for there to be problems. That doesn't happen very often.

The S&P 500 is the reference security but CAIE targets a volatility that is about double the S&P 500. That sounds scary but the fund is comprised of 52 different autocallables such that one matures every week and get replaced by one maturing later. 

The distributions are allowed to be taxed as return of capital. You'll find differing opinions on that but I think it is a positive. The distributions lower your cost basis so there will likely be capital gains tax due when shares of CAIE are sold. 

I have a theory about how CAIE can keep up with the S&P 500 on a price basis despite having a large distribution. The higher volatility (which I am saying is essentially 2X leverage) allows one X to be the price appreciation and the other X to be the distribution. This does create a path to drawdowns being larger which you can see in a couple of instances on the chart. If the S&P 500 drops 40% from when CAIE was priced (if I understood Matt correctly) the distributions will be suspended until the S&P 500 gets back above the 40% decline line. 

Many times before, I said something like if a product yields 8% in a 4% world, there is some element of risk. That isn't necessarily a bad thing but I think you need to understand the risk you're taking.

I don't own CAIE anywhere. To be direct about it, I do not yet understand the risk, I'm not sure what can go wrong beyond the 40% decline suspending the distributions. If the S&P 500 falls 25% and lingers down there for an extended period, I would expect CAIE's price to fall a lot but the distributions would continue to flow. There might be counterparty risk with JP Morgan who is on the other side of the autocallables.

This is worth learning about, I may never connect on this, we'll see but these are interesting to me intellectually if nothing else which is a challenge to how I view complex products. 

The expectation I would have is equity volatility with a lot of "yield." While it has only been a few months, I am intrigued by the idea that it may have solved the erosion problem that derivative income funds tend to have. 

Here's some crazy portfolio ideas I played around with that are relevant to this post.

Whether these are great or whether they stink, they're pretty close to VBAIX but don't do any favors with respect to volatility. 

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.

Fast, Slow Or Both?

Bloomberg did deepish dive on Norges Bank Investment Management, the sovereign wealth fund of Norway. The fund started 30 years with the origin of the money coming from taxes on energy. Norway has a lot in the North Sea. The fund has about $ 2 trillion making it the largest SWF in the world. 

Its portfolio is 70% global equities ex-Norway, 27% fixed income and then a couple of odds an ends. Being that diverse, it might be a proxy for a total world portfolio which is a topic Goldman Sachs referenced recently and that has received a lot of attention since including this one from Morningstar.

The actual "global portfolio" as Goldman sees it looks much different. 

• 49% Global Equities
• 37% Global Bonds
• 6% Gold
• 5% Private Markets
• 2% Real Estate
• 1% Crypto

Here's a simple way to replicate it.

Using Blackstone (BX) might add a favorable skew to the results but we've been using BX this way for blogging purposes for a very long time so I think it is fair in that regard. 

BLNDX and BTAL are client and personal holdings. I am surprised how closely the global portfolio  tracks to VBAIX. Portfolio 3 puts a different spin on the allocation with funds we regularly look at here. If we add 1% Bitcoin to Portfolio 3, it improves the result but only slightly, like barely noticeable. Obviously, there's a good bit of alts use in Portfolio 3. 

The results seem to repeat in these alt studies but the results are skewed by 2022. Using alts will not give the best result every year, the idea is to smooth out the ride or as Ryan Kirlin from Alpha Architect said in a web event they hosted on Thursday, alts help "chop off the left tail." In simple terms, looking at a bell curve, the infrequent, negative outliers are referred to as being left tail. 2008, the 2020 Pandemic Crash and 2022 are examples of left tail events. "Chopping off the left tail" reduces the impact on your portfolio or as we say, avoids the full brunt of large declines. Using alts is one way to do that.

Speaking of alts, WisdomTree has really done a lot in the space and looking to do more. They have quite a few funds in the space and are expanding their model portfolio offering with a partnership with Banrion. Here's a podcast with a little more info but TBH, don't waste your time. It's 49 minutes where almost nothing is said.

There was a reminder that WisdomTree is (probably) the first provider to offer capital efficient ETFs (return stacking before "return stacking" existed). Their capital efficient funds blend simple betas, not beta and alpha (alternatives) and they seem to track exactly what they intend. The biggest one is NTSX which leverages up such that a 67% weighting in NTSX equals 100% in VBAIX so there's 33% leftover for alts or more equity exposure (risky) or just way to incrementally add a little yield on top of 60/40.

The podcast talked about using a forthcoming Banrion/WisdomTree alt model along with a position in NTSX. There was some talk of BTAL and managed futures and WisdomTree already has an alt model that is heavy in managed futures, some BTAL and a couple of other things. The models are behind an advisor-only login so it might not be ok to give all the details

The alt model is not really a substitute for a "normal" growth portfolio. Putting 67% in NTSX and the rest in their alt model does outperform VBAIX but didn't help much in 2022, it was 125 basis points better than VBAIX that year. If 2022 was an anomaly, and going forward bonds do not go down with equities like in 2022 then Portfolio 2 might do a little better. NTSX allocates to AGG-like exposure so if/when AGG gets hit, NTSX might also get hit.

Blending simple betas for a capital efficient fund seems to work better based on NTSX but maybe not based on the now closed NFDIX which targeted 75% equities/75% bonds, it did poorly and then closed.

We've looked at a few ways to incorporate some of the capital efficient concept in, you can search for "leverage down" in the archive for more.

I mentioned the Alpha Architect web event up above. It was to promote a couple of their alt funds. One that responds to fast declines and one that responds to slow declines. Using jargon that we've used before courtesy of Meketa, we've broken this idea into first responders like tail risk, inverse funds and BTAL and second responders like managed futures and gold can fit into either depending on the circumstance. 

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.

ETF Updates

I wanted to check in on the Cambria Endowment Style ETF (ENDW) which started trading in April. It's an actively managed fund that is "inspired by endowment style investment approaches, the fund is designed to pursue returns across various market conditions while maintaining an aggressive risk profile." It uses leverage.

The fund started as a 351 exchange which is a way to swap out a concentrated, taxable portfolio that has a low cost basis into a more diversified portfolio. To my understanding, it doesn't change the cost basis but it does derisk because the fund is more diversified than the concentrated portfolio. Now that it has been trading for awhile, anyone buying it today would being doing so because they believe ENDW is a good way to add an endowment modeled portfolio. 

I watched the holdings pretty regularly when it first started trading, I curious what Cambria's idea of endowment style would be. It seems like it took a while to get the portfolio fully implemented. It had a pretty large position in Nvidia (NVDA) for what seemed like a couple of months. 

The NVDA probably helped it outperform the other funds in the chart. I threw in NVDA because you can see some similarities between ENDW and NVDA that is far less prominent than the other funds allowing ENDW to outperform the others. If I am drawing the correct conclusion about the NVDA in ENDW, then it's NVDA boost may not be repeatable. 

Shortening the chart to three months and removing NVDA still looks good but it backed off some.

Quick pivot to the Invesco Equal Weight S&P 500 ETF (RSP) compared to the S&P 500.

The divergence is not a new story. In 2023, market cap weighting was up twice as much as equal weight and in 2024 the score was 22-10 favoring market cap weighting. This means the largest companies in the index are doing most of the lifting while the average stock is just muddling along. 

It's not that unusual over the course of stock market history but it's not an indication of health either. 

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 Grantham Way

Here's a quote that Idea Farm attributed to Jeremy Grantham, “the only thing that really matters in asset allocation is sidestepping some of the pain when the rare, great bubbles break.” We've been saying essentially the same thing here since before the financial crisis, framing it as trying to avoid the full brunt of large declines.

A couple of quarters ago, I put the following chart into the update I sent out to clients.

The blue line is not a realistic outcome, it's cherry picked with no reasonable expectation that it would continue going forward but as an extreme example of the concept, it explains Grantham's (and mine) point. 

Some of the declines for the red line have been brutal. The green boxes show periods where the blue line portfolio lagged by a mile and half. Sort of making numbers up, would you rather have a very smooth ride like the blue line to a compounded return of 7.5% or go on the red line rollercoaster to a compounded return of 8.5%? The difference between the two is risk adjusted return. 

Short one 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. 

Can We Solve Dread and Disillusionment

There was a lot of doom to read this weekend. The New York Times wrote about how lost younger men are. Not children, men, men who cannot figure it out or get started or whatever else. This is attributed to how society is evolving related to social media, the inability find work and access to porn and video games. Don't come at me, this is from the article. 

The Wall Street Journal had a negative piece about the current state of being an employee. The short version is that people like what they do but dislike their bosses, companies or both to a point of dread and disillusionment with a lingering uncertainty about what AI means for people starting their careers. 

The comments on the Times article included some of the differences between what kids and younger men did in the old days versus now. Certainly, parents were less involved in minute by minute activities. I was in the generation of getting on my bike and being gone all day, back in time for dinner. If that's not dead, it's certainly very rare. I've long had a theory that the advent of MTV was a very negative thing in this context. Kids just sat around watching videos, eating shitty food and then video games came along to make it worse. Yes crazy theory, I'll own that but still. 

The comments on the WSJ article in part blamed political parties (and a perceived bias of the writer) and tried to offer suggestive input while being a little unsympathetic to the plight of younger workers.

The obstacles to simplicity and happiness are many. We looked at health insurance yesterday as another example, and we discuss problems with Social Security all the time. Geopolitics seems to have deteriorated dramatically too. Now, think about whether any of this is being accurately portrayed in the media. I have no idea what the answer to that question is. Maybe all of this is being sensationalized or maybe it's worse than we're being told. I have no idea. 

I also have no idea how to fix any of these problems from the top down. A big talking point for us is the idea of solving or preventing our own problems, not waiting for "someone" to fix it. We are here for a finite period. It seems like a terrible waste of that finite period to simply wait for "someone" to fix what's wrong or otherwise stewing on how unfair something is.

There wasn't a good spot to tuck this in higher up but the proliferation of drug commercials from big pharma is appalling. The objective there is to keep people buying drugs, not to actually make anyone better/healthier. Part of the problem one way or another is the massive increased rate of depressed people who are on medication for their depressive state. The CDC says that the number of people who are depressed increased by 60% in the last decade. 

To the extent the Times is correct about how much time younger dudes are spending inside playing video games and watching porn, it's no wonder depression rates in that segment have increased. The Ford Foundation notes that "hundreds of common prescription drugs, including some birth control pills, blood pressure medications, corticosteroids, and painkillers, list depression or suicidal thoughts as a potential side effect" which likely contributes to depression issues for middle aged people.

The worst of this might be blaming the "other" political party. The government isn't going to fix it. Our problems are bigger than the duration of our political cycles so instead of trying to prioritize solutions, they prioritize getting reelected. 

That means it is up us to make the most of our time finite period. There are no assurances of success when you try to prevent or solve your own problem but I believe we derive value and self worth when we try. I also am a big believer that people want to help people who are clearly trying to solve their own problem.

It all ties back to how we take care of ourselves. There are no absolutes but less junk food, more exercise and more prudent sun exposure will reduce the need for medications which will in turn reduce the incidence of depression. Less junk food, more exercise and more prudent sun exposure will also directly reduce the incidence of depression. Again, there are no absolutes but there is zero downside to getting healthier. 

One of the comments on the Times article talked about volunteering which is another drum I will always bang, along with health. Actively volunteering provides purpose and meaningful social engagement which probably also have a seat at the table for trying to address these problems from the bottom up. 

It is up to us to make the most of our time here. 

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.