Income Engines

StateStreet has filed for the SPDR NASDAQ MyPaycheck ETF. It will be a fund of funds and while there is surprisingly little information on the underlying index for now, Copilot thinks it will target about a 6% yield. Great name, it overlaps one of the things we talk about here for bridge strategies and it reminds me of the StrategyShares NASDAQ 7Handle Index ETF (HNDL) which started trading in 2018 and targets a 7% distribution that can be comprised of yield, capital gains and return of capital.

It was a lot harder to cobble together 7% in 2018, I remember the fund having a lot more exposure to MLPs and funds like SDIV.

The chart is price only. Right now, the distributions are a shade under 7%. 

SDIV has been paying out closer to 9% with much more volatility and obviously compounding very negatively for anyone taking out the distributions. When I first wrote about HNDL, that URL doesn't exist anymore, I expressed concern that the fund would deplete which it clearly has not done. Thinking back to 2018, "the fund will yield 7% and the price will trade sideways" would have been thought to be very good result, I do think it is a good result. 

Lately, HNDL has been paying more ROC. One third of the fund is in various aggregate bond funds that yield more like in the fours, it might actually be more than 1/3 because another 28% appears to be in swaps that replicate the fund. 

I took a stab at making a paycheck strategy as follows;

BKLN and BSJS are in my ownership universe. 

If all the income is taken out then it would deplete after 27 years per Copilot. That seems a little too optimistic but as a bridge to some financial milestone it could last a decently long time. The withdrawals could be managed to avoid the negative compounding (take less out).

HNDL and our idea held up well this past March when the Iran war started but they both got hit hard during the Tariff Panic, dropping about 15%. 

Although not precise terminology, this idea plays off the concept of carry, creating an income "engine" from a portfolio balance that doesn't move around that much.

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 Social Security Problem Appears To Be Getting Worse

By now, you've probably seen they nudged up the timetable to 2032 for when Social Security would presumably need to start cutting payouts by what the Washington Post says would be 22%. Here's the Barron's report on this story. 

There are plenty of ideas floating out there including raising the full retirement age, lifting the income cap (for 2026, once income gets to $184,000 there is no more payroll tax due), reducing the annual COLA bump, means testing (cutting/reducing it for "rich" people) and even investing it in the stock market.

As a legal matter, they simply cannot pull the money from somewhere else to plug the hole. Apparently the last time they made changes in 1983 they did so just in the nick of time which argues that sitting here in 2026 is too soon to worry about it. To adopt that position is to give Congress the benefit of the doubt and while I am sure they will do something, I don't know about giving them the benefit of the doubt on anything. My point being that waiting until the last minute increases the odds that whatever they do is "unfair" to more people than it would otherwise need to be. 

There's a cliche about a negotiation being good when no one thinks they got a great deal, they got something they wanted but not everything. I would suggest being mentally prepared for feeling a little worse than that when this all shakes out. 

Related, this year's Social Security COLA is now estimated to be 4.7% after this morning's inflation data. Someone planning to take Social Security in 2031 and thinking they will get $4000 in today dollars would get $4866 in 2031. If they have to take a 22% haircut from $4866, they'd be down to $3795. Put yourself in that position with your numbers. As it stands right now, would that much of a drop be a problem? I'm not being critical at all. If that drop is a problem, you've got time to figure something out. Then, all the better if they somehow fix it. 

And a quick follow up, with the recent leg down in Bitcoin, I wanted to check in on the Vistashares Bitbonds 5 Years Enhanced Weekly Distribution ETF (BTYB). The basic idea is that fund seeks to pay out twice whatever the five treasury is paying by harnessing Bitcoin volatility via a synthetic covered call. 

UFIV tracks the five year treasury and YBTC is a Bitcoin covered call fund. In the period charted, BTYB has paid out a total of $0.187 so add 75 basis points back into the decline of 5.5% as of Tuesday's close.

BTYB is down less than I would have expected in the face of how much Bitcoin has fallen. What has probably gone on is that as the price of Bitcoin has fallen, the volatility has gone up which results in the option combo that creates the synthetic covered call going down slower than underlying Bitcoin. The fancy term is gamma. BTYB benefitted from positive gamma. If Bitcoin had gone down in such a way that volatility compressed then BTYB would have probably fared worse.

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. 

Permanent Adjacent?

Meb Faber Tweeted out an article he wrote in 2020 about a "stay rich portfolio" which he called the Global Asset Allocation. Presumably, the article was in support of the Cambria Global Asset Allocation ETF (GAA) which allocates 45% to equities, 45% to fixed income and 10% into alternatives. 

We've looked at GAA before. The allocation is interesting and results need to be looked at closely to understand them.

The overall numbers aren't so hot. The 67%/33% blend is in there because it was mentioned in the article as being good middle ground between all GAA or all T-bills. The DIY version I built as follows;

Gold is mentioned favorably in Meb's article and I know he thinks managed futures is an excellent diversifier. I chose QMHIX for this to start playing with higher volatility managed futures. MERFX and BKLN are client holdings. 

When we look at the Cambria funds, the volatility stats usually aren't that good, they seem high for GAA given it only has 45% in equities. I wouldn't expect 45% equities to keep up with 60% equities but it would be nice for the volatility to be lower than it is for GAA, inline with the DIY version maybe. 

Where the results get interesting beyond the obvious that the  GAA ETF has been doing very well for the last year and half is that it does appear to be differentiated from VBAIX. Differentiation can be good. 

Pivot to a new fund that might blow your mind. It is blowing my mind, not being sarcastic. It's the Porter & Company Porter Index Fund (PPCP) it is a quadrant style fund that is modeled after the Permanent Portfolio but the asset mix is different. It allocates 25% each to... are you ready... property and casual insurers, capital efficient equities, hard assets and short term fixed income. What?

This one is easy to backtest thanks to the iShares US Insurance ETF (IAK).

Which one is which? That's a 20 year run and the lack of dispersion is remarkable. 

Copilot has thoughts. First it says that PRPFX hasn't been true to the Permanent Portfolio in terms of long term bonds. The equity allocation in PRPFX has generally tilted toward quality, not simpler market cap weighting. Gold is gold of course and cash is cash. Copilot thinks "insurers are unusually resilient, capital-efficient, low-volatility compounders that behave well across many macro regimes."

I don't know about that. The drawdowns look pretty rough for IAK. It then told me that IAK isn't the best proxy even though it gave me the ticker in the first place.

At that I point I threw in the towel. Seeing how PCPP trades might shed some light or maybe IAK is a proxy for something else that Copilot isn't teasing out. What's going on then? Leave your thoughts in the comments.

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. 

Tools, Not Return Engines

We've got a lot different things to tie together related to portfolio construction and diversification. 

Cliff Asness wrote a long Tweet in support of a paper from AQR that said bonds don't diversify equities, they dilute equities which I think is a fascinating way to phrase it. There's been commentary from various sources that bonds no longer diversify equities they way they used to (I have said that repeatedly) but Cliff believes "bonds never mattered all that much in 60/40" because as the AQR paper goes on to explore, there are other diversifiers can do the job that people think bonds can do. 

I disagree a little bit, bonds mattered for a long time. They were reliably negatively correlated in a way that doesn't exist anymore. Compensation stopped being adequate for duration long before the top in late 2021 but they did help...until they didn't. 

The actual paper starts off talking about the mistake of replacing bonds with things that actually have more equity-like risk than bonds. They cite "most buffered funds" as one example, they cite private credit as having a 0.63 correlation to equities with equity beta of 0.70. They also noted that some believe Bitcoin can function as an equity diversifier but they are very dismissive of that idea. Per the paper they favor long/short equity with a market neutral bias and managed futures. 

Many of the blog posts boil down to me trying to refine my approach on how to build the 40 in a 60/40 construct. There's value in backtesting but there needs to be a grain of salt added to the process of backtesting per a paper from Long Tail Alpha. Done incorrectly, the process can lead to building around hindsight bias that relies too much on the past repeating. 

How often do we backtest a heavy dose of managed futures and then contrast that to the actual experience of owning managed futures? Too much allocated to any diversifier creates risks to the portfolio regardless of whether there's ever a consequence for that risk. Managed futures always backtests beautifully but since the resurgence in popularity of managed futures starting in late 2021, there have been two very rough stretches, one in early 2023 and then going into the Tariff Panic. I've seen a couple of different sources say how bad early 2025 was but I actually recall early 2023 being worse. Managed futures are great for slower, longer declines but really a flip of the coin for fast declines. 

This is a great quote from the Long Tail Alpha paper.

we’re keenly aware of the historical bleed of a typical left tail hedge, whose value does not come from a strong CAGR, but rather from smoothing out left tail events in a larger portfolio

Or, diversify your diversifiers. You can smooth out the left tail events, meaning reduce a portfolio's sensitivity to outlying, downside market events by owning several different strategies that each have their own unique risks. This approach makes the portfolio more robust in case the next long, slow decline is the one where managed futures doesn't work. Thanks to liquid alts, there's no logistical barrier to having many different diversifiers. 

This chart is from Man. The way to read it is that the green combos provide better diversification than the pink combos.

The take away is not to allocate this way, I think the way to take it is as a reminder that during a draw down, a portfolio that goes narrower than broad based indexes will have things that go up. As we noted the other day, during Friday's puke down, healthcare, financials, REITs and staples generally went up. Whenever the next real bear market comes along, there will be stocks and maybe even a couple sectors that go up. If a couple of alts work as well as a couple of plain vanilla holdings go up or are even just flat, then a the portfolio has a good chance of weathering something more serious than a bad week or month.

Hedgeco.net provides rationale for using alts that aligns with my beliefs.

Investors have become more aware that the classic 60/40 portfolio can fail when stocks and bonds fall together. Inflation shocks, rate volatility, geopolitical events, and liquidity stress have all exposed the limits of relying solely on long-only equity and core bonds.

They go on to talk about alts not as "return engines" but as tools that can fill portfolio gaps. The gap in the context for today's post is how to build the 40 or whatever percentage not allocated to plain vanilla equities. There's even a shoutout to litigation finance (we've looked at this a couple of times) which at this point doesn't exist in a wrapper with daily liquidity. "Liquid alts are most useful when they are mapped to a specific portfolio role." How often do we talk about this point? A lot, because it should be an obvious conclusion. 

Adam Grossman weighed in at Morningstar about his concerns for a coming lost decade. A key to success from 2000-2009 was knowing where else to look. I have no idea if we are going to have another lost decade but the process of planning in case we do should have started a long time ago.

A final note, in Friday's recap, I should have included how the autocallable funds did. We've talked about them some so it makes sense to check in when the market does poorly.

ACYN is from First Trust and pretty new. ACYN targets an 11% "yield" which is lower than the others, Copilot says that ACYN should have less sensitivity to equity declines. That panned out of Friday anyway. 

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. 

Hola San Felipe!

On Saturday night I went down a fun rabbit hole of retiring as an expat to San Felipe, BC Mexico. The catalyst for my rabbit holing was a video on Instagram from a couple selling something to help people figure out how to retire to places in Italy that are just as pretty as the tourist spots but off the beaten path with no tourists. So they said, I obviously have no idea. 

A couple of months ago a dog lady acquaintance of my wife's moved to La Paz, Mexico which is way down near Cabo. San Felipe is about two hours south of the Calexico/Mexicali boarder crossing. In college, we used to go to San Felipe for the first few days of spring break. 

The picture is actually Rosarito Beach, that's me at the net setting the ball in 1989. It's as close as I can get to San Felipe without pulling stuff out of storage. Between the Italy video and the friend in La Paz BC, it just popped into my head, what's going on in San Felipe? 

Based on pictures on the internet, the town has grown a lot which is not surprising but it still very much looks like an outpost to me. It looks like the desert, just next to a body of water, the Gulf of Baja. 

That's a 4 br house for $239,000 on a 30,000 square foot lot. It's in a community that has a golf course with a lake and you can see the gulf in the background. The house needs some work the listing says but the house looks cared for as opposed to neglected. There's weirdness with the garage from the above picture. One of the pictures shows a mini-split.

There are plenty of cheaper houses there too. This one below is asking $179,000, it has 3br but is in a neighborhood. There are complexities to home ownership that are not insurmountable but do need to be worked through. Because San Felipe is on the water, there are a couple of legal residency statuses and each one has requirements for home ownership. There is also a complexity to the land the house sits on. Hawaii has something similar, the terminology in Hawaii is fee simple where you own the house and the land or leasehold where you own the house and lease the land. You'd have to dig in more but this is not unheard of.

For the internet, the best bet is probably Starlink. There is reliable cell signal in town. Many houses there have solar so that's not a problem in terms of rules, it seems like it's kind of recommended along with a generator. The water is still not safe to drink and there is not enough rain for catchment to be viable. Property tax for a $300,000 house would be $300-$750/yr plus there is another annual fee that AI described as sort of a banking/administrative fee to own a house which might tie into the residency issues. 

For serious medical issues, you'd probably need to go to Mexicali which is to say you'd really need to go to San Diego or maybe Phoenix. For routine physicals and dentals, San Felipe has adequate services, likewise for injuries but not Level 1 traumas. Prescott can't accommodate Level 1 traumas either, that is common for smaller towns. 

For under age 65, health insurance can be pretty cheap. Americans can go through a process to enroll in Instituto Mexicano del Seguro Social which would be $2000/yr for both ($1000 each) but doesn't cover preexisting. Paying for services out of pocket sounds cheap, a full battery of blood work would be about $80. 

There is no Costco, Walmart or Home Depot in San Felipe. There are several grocery stores including one that is owned by Walmart so there are Walmart brand items in town. There is hardware store. Interestingly, Amazon delivers to San Felipe.

In terms of safety, the area is rated 3: Reconsider Travel. Highway 5 is the main corridor from Calexico to San Felipe. The suggestion is to drive during the day and stay on the pavement. The Highway is not riskless to be sure but it is in the interest of the crime organizations to keep the highway clear with traffic moving but really, stay on the pavement. The town of San Felipe is significantly safer than the road to get there. 

The population has about tripled since I went there in the 80's but it still is very much an outpost sort of town. Out of 20,000 people who live there, 3000-5000 are American or Canadian. 

We're not moving to Mexico. 

Coincidentally, this morning there is another Barron's article about retiring to another country, primarily Canada, Mexico or the UK. That article tilted more toward people feeling like they need to leave the US for political reasons. The driver here is the financial aspect of trying to problem solve for an underfunded retirement. 

My only experience with healthcare in another country is the care my father received in Spain. He lived there for about 35 years, he got cancer shortly after his 88th birthday and died about six months later. The care he received was terrible. All the years he was there and getting just normal care like annual physicals and treatment for a broken hip when he was 71, the care was perfectly adequate. 

Because I think it plays a role in just about every retirement decision, someone who believes they need to retire in another country to make the numbers work will have dramatically more optionality if they have their health dialed in. 

For the 20 plus years I have been blogging, I have talked about the potential for "something having to give" if the desired retirement lifestyle won't work as a function of dollars and cents. Usually that has meant figuring out how to spend less, working longer in a primary career or taking up some sort of post retirement gig. Something else that might have to give is living in the US. Many countries are considerably cheaper.

We've looked at Ecuador countless times in this context over many years. Since then, political instability and cartel activity have both increased. I've noted that and said maybe an American couple would want to leave in the face of that and maybe they would but according to Gemini, the real story is that Cuenca and other inland expat areas have been unaffected by what has transpired elsewhere in the country. 

Interestingly, Gemini says that Cuenca is far cheaper than San Felipe.

Cuenca is probably safer too. I say probably because San Felipe's stats appear to be lumped in with Mexicali and Tijuana. The climate in Cuenca is quite moderate compared to Felipe being very hot.

Panama gets favorable attention as an expat destination. It is safer than San Felipe and about the same as Cuenca. For costs, it is much more than Cuenca and a little more than San Felipe. The climate in Boquette, Panama is similar to Cuenca because both are at elevation and Panama's healthcare appears to be the best of the three. One other thing going for Panama is that they use the US dollar for its currency. 

Gemini suggests a 3-6 month test run before moving to an expat destination and that the test run should include the worst time of the year like a rainy season or in the case of San Felipe, the summer. That many months should allow time to get a general sense of what it is like to live there (pick an area that you'd actually live in), learn about doing general errands, understand the infrastructure constraints and get a sense of whether a social network can be built. 

It seems like it is getting more difficult to accumulate enough to make retirement work. Whatever anyone wants to attribute the reasons to, it seems like that is a financial reality. Moving somewhere else can be the answer to some (probably) small slice of the population. 

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. 

Rough & Rougher

Wall Street got kicked in the stomach on Friday, or maybe a little further south than that. Stocks were down a lot. Big tech was down a lot more. Bonds with duration were down a good bit, not a ton. Managed futures were mostly lower. Gold was also down a lot. Broad commodities were down a little less than gold. Bitcoin spent a little time below $60,000 for the first time in ages.

Client/personal holding BTAL was up a lot....yay? I'm glad it "worked" today but if BTAL is your best performer then things are going badly. REITs, staples, some financials and healthcare were generally green. 

Are markets worried that rates won't get cut anytime soon with the jobs data the most recent nail in that coffin, or are markets worried that there is no end in sight to the war, is it the excesses related to capex spending/debt issuance/equity issuance in the AI/data center theme, were we simply overdue for a pullback or was it something else? Yes.

Today is a great microcosm though for a lot of the portfolio construction theory we play around with here. Let's detour for a moment to what today's blog post was originally going to be about. Finomial Tweeted out a thread of a portfolio review for a capital efficient strategy that looks a lot like something we would work on here.

Here's the backtest result versus 80% equity/20% bonds (Finomial chose that benchmark).

The portfolio that Finomial posted has certainly been more volatile but hard to argue with the longer term result. It's easy to see that volatility on display in both the Tariff Panic last year and the broad reaction to starting the war with Iran. In the Tariff Panic it was down 18% versus 13.8% for 80/20. That is probably attributable to managed futures getting hit very hard during that event and the portfolio has close to 18% in managed futures. 

The point isn't to pick on the portfolio, it is to understand what the experience of riding through with some huge number in managed futures, or gold, or broad commodities or something else would actually feel like and how difficult it might be emotionally.

This sort of day would be challenging for anyone who is heavy in any of these.

We've talked about 5% in TECL which is not heavy IMO but 20% in one day is not nothing. We've never talked about SOXL which is 3x semiconductors. If it is as simple as looking at RSST and subtracting SPY's result to see how their managed futures sleeve did, then it was the biggest decliner of the ones I follow. I threw in HFGM because it targets twice the volatility of global macro. 

What would that table look like if this was the start of a meaningful move lower? Do you remember that fast panic that happened at the end of 2018? Most clients don't but in that fast event but TECL fell by 60%. Sixty percent in an event that many people don't remember. From July 2024 into early August, so just one month, RSST fell by 18%. I remember one or two very bad days in the first week of August but I'm not sure why RSST would have fallen that much but at the same time VBAIX was only down 4%. RSST came back obviously without issue but how difficult would it have been for someone who was heavy in RSST going down 18% in a down 4% world?

This is a difference between theory expressed in backtests versus actually enduring a market event. How did the portfolio that Finomial analyzed do today? Down 3.41%. That's probably not a number that will induce a poor decision but what about a week from now if equities continue lower and the things under the hood of managed futures continue to run counter to the recent trend (managed futures is likely long equities, long gold and long other commodities)?

I hope I am consistent in saying not to go too heavy into any of these diversifiers but if you are going to put 20% into something like managed futures or gold, I would spend time envisioning what it would really feel like when things take a meaningfully negative turn. 

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 Problems

The picture is of the engineer's compartment from Walker Fire's brush truck (type 6 engine).

The hardware pictured is a reducer, an inch and half double female, 2.5 inch double male and a 2.5 inch double female and you can see there is other items in the bin. These tools allow us to change hose size, make connections to truck outlets and even pair up incompatible thread types (there are two types of thread for some reason). The way I have been describing this to new firefighters has always been to say there is no problem that can't be solved out of this compartment, you just need to know what you're looking for. 

The ETF universe is of course similar. I mentioned taking in a new client for my subadvisor relationship early this week. The client came in with 55% in tech with heavy weightings in many of the names that are front and center for the AI/semiconductor mania that we are currently in.

I am hesitant to use the word bubble, I think mania might be a better word. Semantics aside, there is clearly an excess in this theme. Tech/communications is too big to zero out but I've been saying here for ages that I have been underweight. As of right now, tech plus communications adds up to 50% of the S&P 500. History has not been kind to sectors that get above 30%. Obviously there is no way to know when or even if there will be a consequence but the sign of excess is clear. No exposure is a non starter, repeated for emphasis but underweighting is viable.

For this new client, I sold a lot of the smaller names and shaved down the exposure to the major names he held. My usual tech holding for clients is broad based sector ETF that is heavy in many of the names I was keeping for him albeit in smaller percentages than what we walked in the door with. Loading back up on a sector fund that was top heavy in all the same names made no sense and would have left him very exposed to the same stocks that would be in real trouble if there is ever a consequence to the current AI/semiconductor excess. 

While 50% in tech plus communications is a non-starter for me, 10-12% is too light so into the engineers compartment for the Invesco Equal Weight Tech ETF (RSPT). Instead of 45% in semiconductors it has about 25% and obviously there are no holdings in the low double digits or high single digits. Weaving RSPT in with the holdings we kept/reduced allowed for dialing in some pretty precise percentages to bring him inline with other clients. 

Sort of related with the tech excess, back in May I swapped out market cap weighted ETFs for the few clients who had one for the momentum/quality/value combo we discussed a while back. The momentum ETF is kind of like MCW on steroids and the other two differentiate considerably from MCW and I think the three will combine to give a better result with a less total tech exposure than MCW.

The takeaway here is a point we make regularly which is I am not trying to predict anything, I am trying to avoid, or in this case underweight and obvious build up of 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. 

Autocallable Theory

Larry Swedroe did a deep dive on the Calamos US Equity Autocallable Income ETF (CAIE). The basic idea with the fund is that it owns a series of structured notes that mature each week. The fund targets a 14% distribution. The fund would run into serious problems if it's reference index fell 40%. The reference index is similar to the S&P 500. CAIE has sensitivity to the reference index on the way down but in its one test so far, it captured a lot less of the reference index' recovery which is to be expected based on the structure of autocallables. 

You might look at that and decide right away these aren't for you (XV, SBAR and ACYN are also autocallable funds) but there has been no malfunction with them. 

Some points made by Swedroe; first is that 90% of the distribution is a return of capital. Yes it is a very high percentage. He warns that this has the effect of lowering your cost basis in a taxable account so that when/if you sell the cost basis might be nothing, so you'd owe a capital gains tax. Yes but that would be less than the tax on a true dividend. 

Larry then talks about gains being capped as I noted above which is correct. Don't buy this looking for an equity proxy on the upside. Larry notes the 40% threshold for problems starting, that is called a barrier, and yes a decline that big would be bad for the fund but it would be bad for everything. Don't buy this looking for downside protection. He further equates it to being short a put option which gives some good context for how it should behave.

The next issue is the counter party risk with JP Morgan and the cost embedded to pay the counter party. This isn't quite the threat he makes it out to be, if you don't already know this, don't bet too much of your portfolio on the credit worthiness of one bank. The odds of things ending badly for JP Morgan are quite low but sized correctly the actual risk is minimal.

He picks at the complexity and opacity. Yes, they are both, moreso complex than opaque. The strategy is learnable, I'd argue that these funds are less complex than the typical macro fund. Yes it is not cheap too. This is not a three basis point index fund. 

Larry says the NAV must erode and you can see that with SBAR and XV but it hasn't happened yet with CAIE. It probably will erode but I am always leery of using the word must. 

The article finished with checklist of sorts, what you want versus what you get. Once you understand what the fund does you realize that if you want what Larry says you want, you should find a different strategy.

As a matter of curiosity, I'm always going to want to try to find a plausible use for these flawed products, products riddled with drawbacks anyway. I continue to believe there is a use case for things like autocallables and crazy high yielders as part of bridge to the next financial milestone like taking Social Security or taking RMDs with the expectation that any basket of these will deplete toward zero.

The question/tradeoff goes something like this. An investor is 62 and wants to live off a $200,000 bucket of money until they take SS at their preferred age of 68. The income need from this piece of money is $40,000/yr for six years. If they leave the $200,000 in cash they can get five years, plus a couple of months from the interest. How likely would it be to squeeze out a sixth year or even a 7th thanks to the large distributions (ROC and all).

Using a combo of autocallables, not the craziest high yielding YieldMax funds (think Microsoft and Google, not Tesla and Microstrategy), cat bonds, then a sleeve in something like the BCKT or LDDR ETF which both offer depletion strategies and I threw in WTPI which is a pretty high, not crazy high, yielding  ETF that sells put options and doesn't really erode, it doesn't go up on a price basis but it hasn't eroded. There are countless closed end funds that could be part of the discussion to. 

With enough holdings, like maybe a dozen, any sort of issuer risk, strategy risk or idiosyncratic risk could be reasonably diversified.

Back to our $200,000 example, taking $40,000/yr from a basket of these would leave $57,000 left over after six years and probably get the investor through a 7th year with just a little leftover.

If it works out that a lot or most of the "yield" is ROC, that would not count toward modified adjusted income which could keep someone below the income threshold for health insurance from the marketplace to be subsidized which would be helpful until Medicare starts.

There are several grains of salt to take here related to reduced distributions and an extended downturn in markets but to the extent we do some work here on portfolio theory, this one is pretty far out there but still interesting. 

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 It Ok To Die Rich?

There are a lot of personal finance topics where people draw a wide range of conclusions. Social Security is a great example, take it early take it late? There are plenty of good arguments on both sides of that debate. Another important one even if it engenders a little less passion is how to spend/withdraw from accounts to fund retirement. 

Someone who is too frugal might die with a lot of money leftover unspent, they didn't live their fullest life possible the argument would go. The other side of that is people who spend a lot, too much really and maybe they turn out ok financially or maybe they run out of money with the ultimate goal being that the check to the undertaker bounces (very old joke). 

Bill Bernstein and Edward McQuarrie wrote about this, breaking people down into two groups. One is the richest person in the graveyard which is a phrase attributed to Steve Jobs. The argument against spending too little is that it is not a "rational" choice. The other group is people who are willing to live with the fear of running out of money. I'd use the word stress more than fear; willing to live with the stress they might run out of money. 

Any advisory practice will have both types of clients with most of them in the middle I believe, taking a relatively safe to slightly generous amount out. 

The Bernstein/McQuarrie article gives permission to be the richest person in the graveyard, RPIG as they call it. I can understand the idea of dying with $5 million in the bank after years of living a $100,000 lifestyle would cause some form of regret but if we assume there aren't too many of those out there, Bernstein/McQuarrie validate the utility that could go with having a relatively high number in the bank.

I've made this same point slightly differently, I usually say there is value in never having to worry about money. That doesn't have to mean having millions in the bank. Being able to cover your desired, retirement lifestyle with Social Security and maybe one or two other income streams but not needing your $800,000-$1.2 million IRA seems like a pretty comfortable spot to be in. 

It's very important to figure out what type you are in this context. Although I am very unlikely to accumulate anywhere near $5 million in today's dollars, I am closer to to being RPIG. Not worrying about money is very high on my priority list, it goes hand in hand with independence which is the real priority for me. It's not about being rich, it's about being comfortable; financially independent. 

I'm not saying anyone else should view this the way I do, I am saying figure out where you are on this issue so you're not sitting on a mountain of money at 93 if that would cause regret or so you don't spend 1/4 of your life stressing every up and down of the stock market if that would make your life less enjoyable. 

A quick pivot to something that isn't completely true but might be in the future. I saw a post on one of the socials that Nvidia will pay people $2000/mo to house/host a small server. The idea is that with all the pushback against big data centers, servers about the size of a generator could help alleviate the problem. My first reaction was it can't be true. 

So there's something to it, still in a trial phase. They aren't paying $2000/mo but covering internet and utility bills and providing battery backup for your house? There might be 100 reasons not do this if it ever goes mainstream, I don't know, but it would be worth learning about if it ever was available in your area. What if it does evolve into Nvdia, or some other company, paying you for this setup? Getting even $1000/mo toward a $5000 or $6000 lifestyle seems like a lot, especially given how under saved we collectively are for retirement. 

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. 

No ETFs?

I spent the afternoon working on a project with an advisor I subadvise for so I wasn't able to make time for a real blog post but I have what I think is an interesting observation. His practice is primarily professional athletes and he has a new client he's bringing over from JP Morgan.

The interesting observation is that for the 80 or so equity holdings, they didn't use any JP Morgan ETFs. JP Morgan has developed into strong second tier if not higher ETF provider and this account didn't own any.

Maybe I shouldn't be surprised but I am. 

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. 

Too Good To Be True?

Over the years there have been a handful of reader comments that really stuck with me. One reader joked about the best way to die as being shot by a jealous husband at 110 years old, I told my dad that one and he really had a good laugh. Recently I referenced the reader who put 1/4 of his portfolio into Pozen 20 years ago and then there was a bad FDA ruling. 

Another one came at some point in the Financial Crisis when a reader said to just put it all in Hussman and forget about it. 

I'm not sure which Hussman fund he was talking about so I included both. Hussman is usually bearish and does a great job framing out the prevailing bear case but I think he leans very hard into protecting against the bearish conclusions he draws in a manner that seems to ignore the reality of markets going up the majority of the time. Although stale info, as of last fall HSTRX had 68% in cash versus an average of 6% for the conservative allocation strategy. The period studied is the decade after the reader left the comment, HSTRX has done a little better since, compounding at 7.09%. HSGFX is still compounding negatively. 

There's a reasonable argument for Hussman being a bear market manager but "putting it all into" one strategy that is this defensive is not the answer. 

All of that is a preamble to the iShares Systematic Alternatives Active ETF (IALT) which is a multi strategy fund that includes equity, credit and macro. Based on the description is seems AQR-like.

I wouldn't expect it to have a similar growth rate to equities over a longer period of time but the first six months of trading catches my attention. Just put it all into IALT and forget about it? I doubt it's a magic bullet for equity like growth on the upside but absolute return behavior in drawdowns but who knows?

There's no easy way to assess the holdings as presented on the website so with an assist from Copilot;

That still might not be easy to dissect but it helps at least a little. If it is difficult to understand the holdings then it will also be difficult to break down what is driving results so back to Copilot. IALT has benefitted from carry, look at RSSY for confirmation of how well carry has done lately. Before this latest run doing well, RSSY went down 30%, this happened before IALT started trading so carry can be difficult to hold.

There is an equity market neutral component to IALT's portfolio which is similar to BDMIX, you can look at that fund to get a longer term perspective. In the last few years BDMIX has been on an absolute tear but before that, it had mid-single digit returns more inline with what you might expect from market neutral.

Copilot also gave credit to macro trend and relative value so there is some overlap with managed futures which has also been doing well.

All of these doing well at the same time is not an expectation that anyone should have. It might happen 1/4 of the time Copilot said. If you think about these different sleeves being quadrant-ish like the Permanent Portfolio (completely different types of quadrants), how often do all four work at the same time? The entire premise of the Permanent Portfolio is that no matter what, at least one will be working which implies there will always be at least one that isn't working. "IALT is not designed to produce high, smooth returns. It is designed to produce diversified, low‑beta, multi‑premia returns."

Copilot did say it makes sense as a diversifier for being slightly positive in an equity crash, a little better than that if inflation spikes taking commodities higher, it will probably go down in a credit crisis and it would probably do poorly if yields spike.

Take those expectations though with a grain of salt. IALT is an active fund and might be able to manage around some of that. Or not. There's no way to know. 

IALT would be a complementary alt to managed futures, merger arb, certain long/short equity and macro. It would be duplicative with alternative risk premia (AQR has at least one of those) and carry. I pushed back on managed futures and global macro not being duplicative but it came down to nuance. If you're curious you can go into the AI of your choice to get an explanation or maybe you'd get a completely different answer.

Turning this into a discussion of ways to use AI, this exchange mostly replaces talking to a sales guy. On the plus side for AI, I got un-salesy answers, the AI is able to look under the hood in away I could not and answer questions that I doubt a sales guy could. AI also has knowledge/understanding of other strategies. On the negative side, Copilot could be wrong about multiple things. If I was actually interested in IALT with its complexity, I would probably repeat this exercise with Claude to compare and contrast and then still talk to a sales guy. A call with a sales guy would probably be more productive after having checked in with AI.

I'll track this one. We might now know what the good times look like for IALT, it would be nice to see what the bad times look like or if it can somehow defy the occasional painful mean reversion that hits some of the strategies it uses. 

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. 

If Inflation Doesn't Get You, Forced Retirement Will

Price inflation, not poor returns, is the biggest threat to 4% rule for a sustainable withdrawal rate in retirement. We mentioned that a couple weeks ago when we looked at a podcast that William Bengen sat for with Morningstar. The point came up again in a Barron's article about five tips for retirees to protect themselves from price inflation. 

Here's what Barron's suggested;

• Delay Social Security as long as possible
• Own stocks
• TIPS not bonds
• Make sure cash is actually earning interest
• Own precious metals

The point about Social Security seemed a little odd because no matter when you take it, you get the annual cost of living increase. At this point, hopefully everyone has thought about the tradeoff of getting less money every month by taking it sooner and more money every month taking later but no matter what, you get the COLA.

Equity exposure is of course where a lot of growth will come from. Sizing the exposure correctly isn't always easy but for most people, something in the neighborhood of "normal" like 40-60% will be a good number even if not an optimal number. TIPS versus bonds, if you agree with the premise, own individual TIPS not TIPS funds.

The fourth one is sneaky. At Schwab and Fidelity, there are accounts where the default for uninvested cash pays essentially nothing. You need to proactively buy a money market that has a competitive yield. Schwab says they don't hide this fact but I am not sure they promote it either. The practice seems insidious to me but nonetheless, you need to be on top of this point. 

Precious metals, especially gold, should protect against inflation but gold can be a tough hold with any sort of large weighting. Gold can go a long time doing relatively little versus equities. My preference is think of gold as a diversifier, weighted accordingly as opposed to a core holding on par with equities in the manner that the Permanent Portfolio allocates to gold. 

A building block of understanding that gets some attention but not enough is the extent to which overall expenses can go down when you're older, retired or not. First is not having to save for retirement after you retire. If there is no earned income, then you're not paying 7.5% of income (W2 workers) to Social security. Can you synch up the final mortgage payment to coincide with retiring? Toyotas can pretty reliably last for 20 years so no car payments for a long time. Health insurance versus Medicare is trickier because of the amount that employers contribute to the cost. The thresholds for IRMAA are very high and just about anyone subject to IRMAA is spending a smaller percentage of their income on their coverage.

For most people, their incomes go down when they retire, so then do their taxes. If someone is paying more in taxes after they retire then they are either making more money (seems like a positive outcome) or they lose their spouse which is of course a negative outcome. 

Per a Google search, the median percentage of take home pay that people pay for their mortgage is 30-43%. That's kind of a wide range but it's a big number either way. For cars it's 15-20%. Using Gemini and Grok to try to assess health insurance versus Medicare, it might go up a little for W2 workers but go down for self employed people. Actual expenses could be a very different story. On the Google page with the search results was an ad for an article by Investopedia that said retirees spend $1 for every $6 they earn. That's more than paying Medicare, that would also include out of pocket for doctor visits and prescriptions.

People don't believe this so ok but the types of chronic maladies that people take prescriptions for can be reversed by cutting carb consumption and lifting weights. I can't say it is universally true but is often the case and there is no downside to eating less sugar and getting in better physical condition from exercising. It's a legitimate dollars and cents aspect that ties in with this conversation. 

What about discretionary spending? What does your typical month look like? Despite the word discretionary, how much of your discretionary spending could you actually cut back on if you had to? We don't eat out a ton, so hard for me to say but is it easy for couples to eat out less? Are there things you buy on some regular interval that may not be truly essential but still somewhat necessary that would be difficult to cut back on? My wife gave me a good example, ladies who get Botox. She does not, no judgment from me but how well would "honey, you need to cut back on the Botox" go in households where Botox treatments are a regular thing? What about a house cleaner? 

So maybe with some looking ahead, these sorts of expense reductions without sacrificing discretionary spending that isn't so discretionary can be put in place to help start retirement with a much lower base which would minimize the impact of inflation. If a $7000 monthly nut can be cut in half because there is no mortgage payment or car payments, then the impact of inflation on a $3500 monthly nut would be much easier to absorb. 

All of the above was about coinciding with a planned retirement date. What about those who end up having to retire sooner than they expect? Here's another Barron's article where the latest data says more than 40% of Americans retire sooner than they planned. That seems like a huge number but whether it is accurate or not we know it to be the case for many people. 

Someone who is 55 today, thinking they want to retire in 8-10 years should probably do what they can to move up the timetable on all the things we're talking about today. Health insurance stands to be a big threat but with incomes below $84,000 for a couple, plans on the government plan are very (fully?) subsidized. 

The solutions to planning and threats to whatever plans we make are up to us to figure out for ourselves. I find it easier to work on creating income streams to add to potential portfolio income I might take and Social Security when the time comes. I have general preferences of continuing to work, delaying SS until 70 or close to it and having a couple of small income streams for an extra margin of safety. I find it interesting that my preferences aren't really changing. I think these ideas go back to before I was 40, I'm 60 now. There's nothing truly enlightening there, just interesting.

I try to be consistent in not saying everyone should about when to take SS or the rest of it, I'm more trying to convey my thought process that gets me to a conclusion that is right for me. Certainly, everyone should understand tradeoffs but once you do, take the appropriate path for your circumstance and beliefs.

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. 

Rebalancing vs Derisking

We'll start with this from Michael Kitces.

I've never been much of a strict rebalancer so much as a derisker. We use the word ergodic (ergodicity) here to talk about the natural tendency or inertia of equities to go up. That applies to sectors and good lucky stock picks. If the starting weight for a stock in a portfolio is 5% and it grows to 6.5% that means it is outperforming the portfolio but I don't think it is ideal to shave that down in the name of rebalancing. 

Meb Faber has asked rhetorically on Twitter a couple of times whether or not it is a good idea to buy gold when it is at all time highs. He said it is not a good time, it is a great time and of course has data to back that up. I am not concerned with taking that input literally so much as to take it as a reminder that setbacks along the way notwithstanding, broad equities tend to go up, same with sectors and same with many stocks (not all stocks). This is a variation on the Lindy Effect.

My preference is to think about reducing risk. I start most individual stocks at 2-3% of the equity portion of the portfolio. Over the course of more than 20 years of managing client portfolios, there have been several instances where individual stocks went on absolute heaters and did so for an extended period. I don't have a hard and fast rule about what percentage weight I take some off the table instead it is more of a combination of things to consider. It doesn't get better than this is a good time to take a little off the table. Also it is pretty easy to look at a chart and see where something has gone parabolic. The context here is not that something negative has happened to the company, just whether or not it has grown too large in relation to the portfolio.

At what percentage weighting would an implosion be problematic? If Sandisk now made up 5% of your portfolio and it cut in half, would that be problematic for you? What if it was currently at 10%? We're not trying to pick a top or predict something bad happening, this is simply a matter of risk management. If giving up 500% points quickly because of some sort of calamity for the stock would be too much, that tells you to sell some. I wouldn't sell all of it unless there was something negative about the company prompting action, I would sell enough to get down to an acceptable risk level if something terrible happened.

This gets us to looking through to your exposure to various sectors and themes in ETFs and making decisions about what sort of weighting to have. For example, the S&P 500 has just under 8% in Nvidia and about 18% overall in semiconductors. For someone who is a real indexer, they are probably content to have that much exposure. But from there, how many portfolios own both the S&P 500 and QQQ?Nvidia is just over 8% of QQQ and semiconductors are closer to 30% of that index. 

Copilot says there are at least 40-60 narrower ETFs that own Nvidia at more than a 5% weighting. One of the advisors I started subadvising for last year were quadrupling up on Nvidia exposure with the S&P 500, QQQ, SOXX and the actual stock. This would have been great for returns and terrible for risk management and the advisor didn't realize the duplication he had.

If you want to build that way by all means, make an informed decision and go for it but the point is more often than not, people do not realize the extent to which they are loading up on the same risk. That won't be a problem until it is a problem. 

Do you have emerging market equity exposure? Have you looked at what is going on with the holdings? Chances are the fund you use is heavy in Taiwan Semiconductor, Samsung and SK Hynix. So that is another avenue to the same sort of risk/theme. If you've looked through to your holdings and know what your exposure adds up to and you're comfortable with that weighting then you're all set. 

The top five in EEM add up to about 30% of the fund, tech more broadly is just shy of 37%. It is important to understand these exposures not to avoid being overweight the sector or the AI theme but to avoid being unintentionally overweight.

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 Great Result That Would Be Very Difficult To Live With

We've got a lot to pack in today starting with a two hour podcast with Jason Buck who created the Cockroach Portfolio and Jim O'Shaughnessy. I hopped around a bit and took in maybe 45 minutes. There was a lot of deep stuff, Jason is a complex guy. There are just two points that I wanted to explore here.

The first one is the difficulty in holding diversified portfolios. Jason cited the cliche we say here that if everything is going up together, you aren't diversified because they will all go down together. In other interviews Jason has said that being diversified means there's always at least one holding that will make you want to puke. 

We'll dig in a little on the Cockroach Portfolio in a moment but he talked about trying to talk people out of investing in his fund because of the behavioral challenges that go with sitting in one holding, even if it has a small weighting, that is down most of the time (your diversifier). 

Jason has talked frequently about Nassim Taleb and Universa (a hedge fund that specializes in tail risk strategies) but I didn't realize the influence that Universa had on Jason. He said the Cockroach came about from reading Taleb and then trying to reverse engineer the concepts that Taleb wrote about. 

Here's how the Cockroach is allocated;

Below is the most recent version of the Cockroach that we tried to reverse engineer;

And here is how it has done through yesterday;

I threw in the Permanent Portfolio Fund (PRPFX) because quadrant style investing is also a source of influence on the Cockroach and I included the Trinity ETF (TRTY) because I think there is some conceptual overlap. We can't really backtest further than with BTCFX for Bitcoin because if we use GBTC we would get some results that I don't believe could be repeated but for the almost five years, the Cockroach has done very well. It kept up with PRPFX and outperformed VBAIX with a lot less volatility than both of them. 

While that is good of course there are a few holdings that do dreadfully bad occasionally. There might be a better mousetrap than TAIL but that one is a tough hold. Managed futures funds are frequently difficult to hold. Bitcoin is currently in a 40% drawdown. I think people give gold the benefit of the doubt but 12% is a lot when it's on a downswing. All of that and our version of the Cockroach works.

Here's a more extreme example of holding something that goes down a lot from time to time from an article that tries to deconstruct Mulvaney, the CTA shop that made news for making a fortune on cocoa a couple of years ago. 

80% of their trades lose money? The long term result is fantastic but the drawdowns can be brutal. The strategy is that trades are small and allowed to grow unconstrained until they get stopped out, constantly increasing stop levels for a trade that works. Risk is managed with stop orders not position sizing or risk weighting per the link above. A reader turned me on to the article when I asked if anyone knew about any funds more volatile than MFTNX that we looked at yesterday. 

Pivoting to leverage that I think I can weave into today's discussion, Jeremy Schwartz from Wisdomtree sat for a much shorter podcast with Ben Carlson. Wisdomtree has quite a few capital efficient (leveraged) ETFs and they appear to do exactly what they say they will do. Part of the argument in favor of these funds is that the leverage is not being used to magnify one position, instead the leverage is used to add diversification without having to take away from the stocks and bonds allocations.

The idea makes sense but that doesn't necessarily remove the risk that the disparate assets in the fund both go down. If sized appropriately, that isn't necessarily catastrophic but while VBAIX was down 16.87% in 2022, NTSX, which leverages up such that a 67% weight to it equals a 100% weight to VBAIX, was down 25%. The math checks out in terms of the fund working correctly but sized incorrectly, 25% is a big decline. Additionally, with the stocks/bonds combination funds, you have to want the bond exposure they offer. NTSX has AGG-like bond exposure, RSSB has a treasury ladder of sorts that takes on plenty of duration. 

Stocks and bonds can go down together. In terms of being willing to look different, these funds are about not looking different. The ReturnStacked guys talk about their funds helping to avoid tracking error. The bond market is a great place to want tracking error, to want to look different. The benefit of looking different with respect to bonds for individuals is less volatility and the benefit of looking different with respect to bonds for portfolio managers is better risk adjusted performance.

Here's a little more about effective use of leverage from RCM.

We've looked at leverage a little differently. More real world, we've looked at how a small exposure to negative convexity can allow for a little more exposure to equities. Not a lot more, a little more. If equities start to decline, the fund with negative convexity will grow to hedge more of the portfolio. A little more theoretically, we've done some things will small exposure to SSO which is 2X S&P 500 and much smaller exposure to TECL which is 3X technology. Putting 5% into TECL only to see it blow up would be a bad outcome of course but no catastrophic.

Investors are leery of leverage which is a good starting point but as the pro-leverage crowd will tell you, serious problems comes from misusing leverage. I would tread very carefully with any of this and I would avoid a fund that leverages equities and duration. I don't know if there are more bond market declines coming but I do think there is more bond market volatility coming.

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.