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.
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