What To Do If Tech Is Ground Zero For A Bear Market

Today let's play around with the Alps Equal Sector Weight Fund (EQL) that we looked at the other day. I wanted to try to build something out was simple with a little robustness in the face of market adversity. I built out the following, one with market cap weighting and the other with EQL. Everything except SHRIX and EQL are in my ownership universe.

They're identical except for VOO and EQL.

It probably only makes sense to consider EQL if you are concerned about technology and communications being ground zero for some sort of really big decline. EQL has lagged for having less in tech and communications so I would expect EQL to outperform if tech does something hideous in relation to the rest of the market. Both versions have much lower volatility and held up quite a bit better in all the drawdowns except for the 2020 Pandemic Crash.

As is the case with most of these exercises we do, not having any bonds with duration is a big driver of the results with BLNDX and BTAL chipping in too.  

Short post, we had a very small wildfire today that took some time. 

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. 

Broken Benchmarks

Here's a doozy. Nicolai Tangen who is the head of Norway's sovereign wealth fund is very concerned about the economic fallout from the war in Iran. He's modeling in a 49% decline for the fund's equity sleeve and a 37% decline for the fund overall. That doesn't appear to be a prediction, it appears to be one possible outcome out of many from an analysis they ran. 

Here's an even bigger doozy from Ted Seides who says the S&P 500 is broken as a benchmark due to concentration issues primarily, but that the concentration causes other problems that skew passive versus active investing. Something is just off because of how badly passive is beating active, it doesn't make sense in terms of magnitude or persistence he said. 

He notes single stock volatility is pretty much at all time highs which helps the largest tech companies dominating the index. He also said there is more chop at the sector level too. The 44% in tech plus communications should cause us to "rethink what that means for portfolio construction and performance measurement."

We've talked before about the tech sector tending to outperform the broader index in both directions most of the time. If the S&P 500 is broken because too much is in tech and communications and too much is in just ten companies then that causes all sorts of problem with portfolio performance measures for larger pools of capital like mutual funds and hedge funds. At some weighting to tech  stocks you've got these types of vehicles benchmarking to the tech sector not a diversified index. Ted's context included the extent to which the industry is entrenched deriving alpha versus the S&P 500, the index is used for beta and although not part of the formulas for Sharpe Ratio and Standard Deviation, the index is the comparison. 

"Equity market exposure should provide broad-based, diversified, liquid exposure to economic growth. Today’s S&P 500 ignores most sectors in the economy, while favoring sectors that have been winning and are highly exposed to the future of AI." 

"In today’s equity markets, diversification no longer resides in the cap-weighted S&P 500."

This is less of an issue for advisors. If a portfolio is doing what the client needs in terms of risk/volatility tolerances, kicking off a sustainable income if needed and capturing growth then that is what matters. So from that perspective, benchmarking an advisory client to the S&P 500 is fine. My clients have nowhere near 44% in tech and communications, that is a lot of potential risk that is easily avoided. There's no way to know if there will ever be a consequence for that risk but the risk is there all the same.

If something terrible happens to the broad index, it seems pretty logical to think it will be tech plus communications that will take the worst of it because that is often how it goes but a little more bottom up, there are plenty of signs of current excess with those two sectors. 

You've probably heard of the the Invesco S&P 500 Equal Weight ETF (RSP) which as the name implies equal weights all 500 constituents of the index so Nvdia has the same weight as Organon. Less talked about though is the ALPS Equal Sector Weight ETF (EQL). I wrote about this fund when it first came out in 2009 for theStreet.com.

According to my article in 2009, tech's weighting (which included communications back then) in the S&P 500 was 18% versus 44% for those two now. RSP now has a combined 17.1% in those sectors. After rebalancing, EQLs weight to the two is 18.18%. The chart shows differentiation between RSP and EQL versus the S&P 500 and I threw in SCHD which only has 13.5% in tech plus communications. You can see they started out similar but then VOO pulled away as tech started to outperform at an accelerating rate. If tech continues to rip then yeah, RSP, EQL and SCHD will fall further behind but if the idea is not wanting to be front and center to a tech implosion while still using broad based index funds, these should be looked at. 

Strategically, I think this is where capital efficiency in terms of leveraging down could come into play. This space is evolving. Quite a few providers offer funds that leverage up like the ReturnStacked Funds which tend to be 100/100, WisdomTree has several that are 90/60 along with a couple of others that are 90/90, Simplify has a couple, Unlimited has a couple that target twice the volatility, and there are some one offs out there where I bet the providers will increase their offerings. 

The latest one that came out this week is the WisdomTree Efficient US Plus International Equity Fund (NTSD) which is 90% domestic and 60% foreign. For an equity allocation, a 67% allocation to NTSD with 33% in cash could equal 100% of an unleveraged equity allocation with no cash leftover. There might be a slight performance dispersion one way or another but whatever happened to equities, 33% would be sitting there in cash. If the 60 domestic /40 foreign equity sleeve fell 30% then you'd expect NTSD to fall 45%. With 33% in cash, the dollar consequence would be the same but the cash would just be sitting there. 

That strategy wouldn't address the index concentration issue but for a $100,000 equity allocation, there'd only be $67,000 exposed to risk assets. 

We've looked at examples likes this before. With just about every 2X fund, the dispersion between the index a two times the index in a fund is very wide but SSO has been pretty true to capturing twice the S&P 500. As the capital efficient space evolves, this concept might actually make sense to do. 

The information, analysis and opinions expressed herein reflect our judgment and opinions as of the date of writing and are subject to change at any time without notice. They are not intended to constitute legal, tax, securities or investment advice or a recommended course of action in any given situation. 

Cross Asset Dislocation

The way the current market event is playing out, most higher volatility diversifiers are not doing well. The most curious case is gold. The other day we talked about gold maybe having priced in something bad happening in markets as it ran higher at the start of the year. In late January a few of the accounts I manage for other advisors had grown to more than 10% in gold, the previous manager believed in a higher allocation than I do, so I reduced their exposure. It's really a big deal to size things appropriately. At some weighting gold goes from being a diversifier to being a source of unwanted volatility. 

Gold's decline is odd to me. The price of energy going up makes it more expensive to pull gold out of the ground. That makes sense and sounds like a negative factor for the miners, the miners dropping makes sense. But this concern would seem to put downward pressure on new supply coming online so gold getting clocked seems like some sort of dislocation. It happens.

Client/personal holding BTAL has not been doing well for the last week or so as we mentioned the other day. Tech already dropped a fair bit coming into this and so since the war started its been down less, XLK is about 200 basis points better this month than the S&P 500. 

Foreign equities getting clocked. Miners getting clocked after a fantastic run, I mentioned shaving that exposure down a little bit earlier in the year, it's important to size things correctly repeated for emphasis. Managed futures is limping along, as we said the other day we're still inside the initial 10% decline where manage futures doesn't necessarily kick in but I don't think it's the poster child for the markets' struggles like maybe gold is or bonds with duration which have been dropping in price over inflation concerns. Inflation concerns are another reason why you might expect gold to be doing well. 

Things that have been working are the holdings that should look like a horizontal line that tilts upward. Anything with energy market exposure is probably up but of course holding on to those parts of the market is very difficult for the volatility the 99.9% of the time we're not in a war that threatens the energy markets. Also, straight inverse funds are working correctly. 

No diversifier can work in every single adverse market event which reiterates the idea of having correct sizing of not just alternatives but everything. You don't want to find out you had too much exposure to equities after a large decline. Some diversifiers will work and some won't in a particular event. Maybe all will work in another event. Either way, diversify your diversifiers. 

Gold is down low double digits. Will it keep going down? Who knows but if you have a 20% weighting you might be really sweating this decline. Get the sizing right.

Here are four all-weatherish funds that we talk about with varying degrees of regularity. AOR is a 60/40 fund. ALLW is a Bridgewater strategy. PRPFX is the Permanent Portfolio. Trinity is heavy on trend. And BLNDX is a long time client and personal holding. The chart doesn't capture PRPFX dropping 119 basis points on Wednesday or BLNDX' drop of just 19 basis points. TRTY and PRPFX are both doing better than I would have expected but they're not impervious to the broad decline. That speaks to the challenges that the war is posing to markets. 

I forget where I first heard this but the idea with what we talk about in terms of defense, using alts and avoiding the full brunt of large declines is that we are trying to chop off the left tail, the large and negative outlying return. Right here, we're in about a 6% drawdown which is not a large and negative outlying returns. If you use any sort of defensive or diversifying strategy, if the market continues to decline then I would expect to get a type of convexity effect like maybe gold will figure it out, maybe more trends fall into place instead of the recent chop which would help managed futures and so on.

Whatever this event becomes, it will eventually end and then the market will start to work its way higher, eventually making a new high. The only variable will be how long that all takes. 

And a quick follow up, Bloomberg is reporting that S&P lowered its outlook on Cliffwater Corporate Lending Fund (CCLFX) to negative based on concerns about redemption demand.

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. 

C'mon Gen-X, You Still Have Time To Rally

In more than a couple of instances, I have titled blog posts C'mon Gen-X, Time To Rally about my generational cohort having trouble getting to where they need to be in order to retire without making enormous sacrifices. I would count not actually being able to retire as an enormous sacrifice as well as not being able to spend money on anything but the most basic of needs; food, shelter and healthcare.

The prompt for this post was a quick look, really not a review, just a cursory look at a book called Retirement Bites which is a play on words for the Gen-X anthem-ish movie Reality Bites. As an older Gen-Xer I'd say that Breakfast Club or to a lesser extent Pretty In Pink defined our cohort. The book is written by Kerry Hannon from Yahoo Finance. Here's a gift link that has more about the book.

Hannon and her coauthor Janna Herron believe in needing to figure any psychological hangups people have with money like growing up with very little money or any other sort of financial trauma. I'm not huge on this but I might have a bias here. My parents were terrible with their money and it was easy for me to recognize as a kid how difficult they made things for themselves. I've described this before as benefitting from their mistakes. 

All aspects of retirement should be long term focused. If you have been accumulating money along the way, hopefully you started at a youngish age. As you approach 50, still a long way from retirement, hopefully you make some effort to understand what sort of numbers you will need with more depth than just saying 80% of your income or some other vague rule of thumb. 

Social Security also lends itself to long term planning. Here's the latest from Bloomberg that points to benefits being reduced as soon as 2032. The thinking is still cuts to payouts just under 25% which is not a new number and while it sounds big, anyone paying attention has known about this for years and still has quite a few years to go to figure out how to mitigate the impact. I still don't think there will be a cliff for people above a certain age but I see less commentary/theory agreeing with my assessment. 

Social Security wants us to know how much we're getting in today's dollars, so then just lop off 1/4 to know what you're likely to get. At 50 or 60, you have plenty of time to digest the numbers and plan accordingly. 

There is wide agreement that Social Security, reduced or not, is not intended to be sufficient for most people but it can be significant. A $3000 payout as part of an $8000 lifestyle is significant. We talk all the time about figuring out how to monetize something like a hobby or a volunteer gig. This also needs to be a long term process to create, or at least odds of success go up playing the long game with this. 

Sticking with the $8000 lifestyle example, bringing in $2000, $3000 or $4000 from a monetized hobby or volunteer gig turned paid gig would again not be sufficient but would be significant. 

Bloomberg also talked about retiring to another country, focusing on France, Costa Rica, Spain, Italy and Panama for this article. One of the comments on the WaPo link for the book review glance said he rents his house out in California and lives in Central America. That is exactly what we've talked about here. There are plenty of places where Social Security plus rental income from a mortgage free house back in the states will be sufficient in case the retirement account is more of an emergency fund. 

We've talked countless times about keeping the house in the US in case you need or want to come back or get out of where you moved even if just temporarily. We last looked at Ecuador in this context  but the war in the middle east is another example. This article from the WSJ creates the impression that Dubai was believed to be impervious to any sort of mid east conflict. It seems like an easy risk to mitigate, something going really bad in whatever country you chose and having an easy option to come back. 

What about continuing to work? Plenty of people are desperate to stop working while others never want to retire. Continuing to work can go in several directions like scaling down hours and then sticking with it for a while or maybe delaying retirement by two or three years to build up account balances, reduce (even if just slightly) the number of years that the money needs to last or in some cases literally never retiring as a matter of choice. 

In the meantime though, the way the Retirement Bites authors describe it, Gen-X is in a lot of trouble. At 50 or 55 or 60, someone making a decent income but that just never got around to saving money due to life circumstances could plausibly find themselves mortgage free, kids up and out and now able to start saving. That is not too late to build up a bit of a retirement fund. At 60, with no retirement savings, only a generous pension would spare that person from having to work a good bit longer but 10 or 15 years is enough time to build up a piece of money that would generate a significant income in the context of our $8000 example above. 

I'll close out by paraphrasing Joe Moglia, no one will care more about your outcome than you so c'mon Gen-X, you still have time to rally. 

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. 

It's Not Catastrophic, It's Just Not All-Weather

A while back we stumbled into an interesting blend of fixed income ETF with 50% in iShares MBS ETF (MBB) and 50%,

Backtesting to RISR's inception, it struggled a little in 2022 when the treasury market was blowing up but that was nothing compared to TLT and for the most part it has looked like T-bills. It's interesting that the price only return is almost the same as T-bills.

I asked Copilot what the story is here. It looks kind of bullet proof. I realize it's not but I want to understand the risk. MBB and RISR have been negatively correlated, almost perfectly so, which is why the blend looks like that. 

Copilot said that the negative correlation would flip positive if mortgage spreads widened dramatically, citing 2008 and 2020 examples with late 2022 as being modestly negative for the blend. Copilot theorized that in 2008 it would have been down 9-10% and in 2020 it would have been down about 8%. In 2022, there were two negative months in a row adding up to a little less than a 4% decline. 

I pushed back that "The arguments you're making seem to say it won't do very well when there is absolute calamity but even then the results aren't catastrophic. They're just not that resilient." 

"A 50% RISR / 50% MBB portfolio is not a ticking time bomb. It’s not going to implode, it’s not going to behave like high‑yield credit, and it’s not going to deliver catastrophic drawdowns even in severe stress." Then it said "it's not catastrophic, it's just not all weather." 

It's "not even particularly bad in the context of fixed income" which literally made me laugh out loud. The original response made it sound this idea was more risky with more volatility than ZROZ which is like trying to hold onto an M80.

MBB/RISR doesn't take interest rate risk but the spread risk would be unique versus the other things we talk about. Whenever the next cataclysm happens, the blend we are talking about today might feel it a little more but the rest of the time, it might look like how it's performed since we started tracking it. 

The information, analysis and opinions expressed herein reflect our judgment and opinions as of the date of writing and are subject to change at any time without notice. They are not intended to constitute legal, tax, securities or investment advice or a recommended course of action in any given situation. 

When Diversified Isn't Diversified

Torsten Slok's Saturday email included the following chart and he said the index' concentration is moving toward 50% in the top ten if/when Anthropic and SpaceX go public.

He said the "S&P 500 basically doesn’t offer much diversification anymore."

Here's a fascinating quote from Jeff Currie at Carlyle, he said "in the 1970s, energy at 25% provided a natural portfolio hedge. At 3%, that hedge has vanished."

Mike Zaccardi Tweeted out this chart.

I think I randomly noticed the duration getting a little longer at some point but I don't really keep tabs on this the way I do for S&P 500 index composition. 

The Oregon Public Employees Retirement Fund has had its hat handed to it for getting lousy returns from its 26.5% allocation to private equity. "They appear to be after the highest-returning asset without respect to risk-return considerations and without regard to their seeming lack of selection skill." CIO Rex Kim is cited as calling the criticism myopic, the fund is focused on the long term. That would be ok except for the various budget cuts, one small school system had to make serious cuts to staff, occurring now not in the long term. 

The tie in for all of this is how to embed robustness or resiliency into an investment portfolio. Here's Bob Elliott from Unlimited Funds giving his thoughts on how important this is.

We obviously spend a lot of time here on how to do that. The balance is walking the line between kneecapping long term growth of the portfolio while not taking the full brunt of large declines or being a forced seller after a large decline to meet income needs. 

Obviously the belief here of how to best do this is to combine small weightings to esoteric fixed income niches and alternative strategies with differing attributes. 

In the past, we've frequently said putting it all in an equity index fund is valid but not optimal. Currie's observation about no built in hedge speaks to part of this, another part is the occasional enormous declines that might reasonably induce a panic sale at exactly the wrong time. The right combo of robustness and resiliency can prevent ever being in a position of potentially panicking. 

The anecdotes about AGG and OPERS are different manifestations of the same issue, not having a great understanding of how risk works. Also with OPERS, if there really are budget cuts now because "long term" investments are doing poorly, then the investment team has mismatched its assets versus its liabilities. 

Making portfolios more robust is not rocket science and it gets a little easier when you can accept that not every alternative strategy or esoteric fixed income niche will do well in every single adverse event. That is why you diversify your diversifiers. 

Don't make it harder than it needs to be. 

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.

It Just Has To Work

Barron's laid out a path to a stagflationary outcome like we had in the 1970's noting the dynamics of the oil market being the primary factor. The Friday growth revisions and inflation data didn't help to refute the argument. 

Bloomberg took up a similar conversation talking about what various investment firms are doing to help with the current equity volatility against a backdrop where plain vanilla 60/40 isn't really working.

There was a bit of a spaghetti thrown against the wall aspect to the different strategies expressed in the Bloomberg article. Bonds often work in times like this but are not for reasons we've gone over ad nauseum. What about gold? It sort of isn't working but I have a different take. Gold already worked. Arguably it priced in some sort of turmoil rising about 70% in the last year.

Are there some equities working? Yes but there are always some equities working no matter how bad it gets. For this event, defense stocks certainly have been working until the last week or so, rolling over a little. They also might have priced in turmoil ahead of time. 

There was no mention of managed futures which have been interesting in terms of the dispersion of performances. Over longer periods, performance dispersion seems more like magnitude but in the same direction. The long list of funds I track collectively seem to be doing different things on a daily basis. The differences probably come down to different types of signals used as well as risk weighting of positions. There have been times were managed futures has just been killed during equity market volatility, the first 10% down, but that isn't happening now. 

Another Bloomberg article suggested buffer/defined outcome funds instead of bonds to help with equity volatility. Buffer/defined outcome funds certainly are not malfunctioning through this, so that's good. I have no reason to think they would malfunction but the basic ones will not be proxies for equities when you want them to be. 

Inverse funds are mostly working. But client personal holding BTAL had a couple of disappointing days in there when the S&P 500 was down (good for BTAL) but software stocks had a bit of a recovery (bad for BTAL) that seemed to puzzle people but happened all the same. Going to heavy in inverse funds becomes counter productive at some weighting as too much of a drag. I'm not sure where that line is but mid single digits is not counter productive. 

REITs have been doing well which is a bit of a surprise with rates going up. REITs have tended to disappoint in times of turmoil more often than not and yieldy REITs tend to go down when people can better yields from bonds. 

The last (only?) time there really was stagflation, foreign equity markets outperformed the US. This was the case in the 2000's albeit with a different circumstance.

Foreign has had a bad week but a real stagflationary event would last more than a week or two and I would want foreign equity exposure in that instance. 

What all of this is about is diversifying your diversifiers. Forty percent in bonds, not working. Meb Faber has tweeted about how close 60/40 stocks/bonds is to 60/40 stocks/gold over long periods. Great but gold this month is not working. On the next event, maybe both will work and the things doing a little better now will do very poorly

There's no way to know when some random diversifier you believe in just will not get it done. It would be nice if gold was working this month but I don't want to put clients in a position where gold has to work just like anyone putting clients into 40% bonds is putting them into a position where bonds have to work and they aren't. 

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.

There's An ETF For That?

YieldMax dialed it way down for its new US Stocks Target Double Distribution ETF (DDDD). Instead of yielding 50%, DDDD will target twice the distribution rate of the Schwab US Dividend Equity ETF (SCHD). SCHD yields about 3.5%. DDDD owns a slug of SCHD as well as quite a few of the individual stocks in SCHD. 

The fund will overlay option combos on SCHD as well as some of the holdings using call spreads, selling puts and a couple of other strategies occasionally. The boilerplate says the fund may return capital as part of its distributions. 

Copilot said that based on the current holdings, the dividends generated before any options are implemented should be 3.4-3.7%, in line with the fund. 

I'd be surprised if it had to return much capital to find the extra 3.5% yield. I suppose it might want to do that for some reason but I doubt it would have to. The extra drag then from the higher distribution versus SCHD would only be 87.5 basis points per calendar quarter. I can't imagine it would look like any of the crazy high yielders that move down and to the right on a price basis very swiftly only to then reverse split and then repeat the swift decline toward another reverse split.

We talk about using small allocations to the crazy high yielders in some sort of depletion or drawdown strategy. DDDD simply paying a little bit more should be plenty sustainable for anyone who would rather take yield out than sell from more of a total return approach. 

For all the talk about private equity/credit firms, it turns out there is a pretty narrow based ETF tracking the space. The Van Eck Alternative Asset Manager ETF (GPZ) only has about nine months under its belt but it appears to do a good job tracking the industry which lately means the price is down a lot.

That's not all the holding but it's most of them. Not captured in the screenshot is Blue Owl with a 3.28% weighting. There's no Goldman, Morgan Stanley or any of the other multiline financials that dominate funds like the following;

While I can't see ever wanting GPZ, there is probably useful information keeping tabs on it.

I'll close out with advice from Barron's about The Best Way To Trade A Volatile Stock Market which is that investors "should do as little as possible." Maybe put differently, do less. If you've been reading this blog for a while, hopefully you recognize the pattern of small tweaks when risk factors change, not necessarily as an emotional response. That's the objective 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.

Duration Is Not The Answer

Something I don't think I've ever talked about before but I am not a fan of fixed income duration.

We have of course talked about this so often that I am sure I've lost readers for banging the same drum over and over for so many years.

The screenshot is just a nanocosm, a moment in time but it captures the unreliability of fixed income duration. 

There is some yield where ten years or 20 years is adequately compensated but four point something percent isn't it. If we ever get a yield that you think does provide adequate compensation for ten years or 20 years, just buy the individual issue, don't buy the ETF.

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.

Mr. Potter's Investing Philosophy

 Boaz Weinstein isn't selling, he's buying.

Or trying to buy anyway, distressed assets from a couple of the fund providers like Blue Owl for 65-80 cents on the dollar. We talked about this the other day. I don't think the takeaway is to also try to buy distressed private credit assets. I'm not even sure what that would look like, Weinstein is trying to assets out of funds like Blue Owl and the others, so to buy shares would appear to mean buying a fund that just sold on the cheap if that's what happens. 

What the point is that we can take away from is about not panicking when things go poorly for random holdings. If you include sector funds in your strategy, I do, a sector isn't going to go to zero. If you've sized it correctly then there should be no need to sell just because it is down. To Weinstein's point, it would be a time to buy pessimism as he puts it. The better sale would be to sell excessive optimism. In January I shaved down SPDR Metal and Mining (XME) by about 20%. It doubled in a year which is great but maybe excessive. 

I'm not a buyer of the private credit pessimism. The whole space reminds me of trying to hold onto an M80 but without the Bitcoin-like upside potential. I take that back. The common stocks of the private credit companies do have that potential but that would add a lot of volatility to a portfolio. We look at Blackstone (BX) frequently for blogging purposes. It is down to $107 from $199 in November, 2024. 

I don't think there's a reasonable risk of it failing, might not be as confident in Blue Owl, but while I don't doubt it gets back to $199 and higher eventually, maybe the path back to $199 goes through $60 first. I don't know either way in terms of price of course but in terms a volatility, I would expect the moves to be huge in both directions. Including that sort of volatility in a portfolio makes sense but again, it needs to be sized correctly and considered with something else that might be just as volatile. Having 5% in four or five holdings with this kind of volatility is going to be painful if the market whooshes down and that would increase the odds for panic selling for the investor who didn't understand what they were getting into. 

We've been talking about redemption requests impacting private credit funds and that appears to now be happening with Cliffwater. I haven't seen any reports that Cliffwater's assets are impaired so assuming they are not impaired, a bad outcome could just simply be a sort of contagion effect. People believing the entire space is in trouble could be looking for liquidity anywhere or as we quoted in a different blog post, no one wants to be the last one out.

"Hi there, it's Cliffwater. I need to sell some paper right now to meet redemptions."

"Hi Cliffwater. How's 85 cents sound?"

These things are complicated and expensive in addition to being illiquid. 

The information, analysis and opinions expressed herein reflect our judgment and opinions as of the date of writing and are subject to change at any time without notice. They are not intended to constitute legal, tax, securities or investment advice or a recommended course of action in any given situation.

Risk & Diversification

Here's a doozy of a Tweet.

It's not a joke (nice timing on the screen grab). That's the CEO of Strategy pumping one of the company's variable rate perpetual preferred issues. 

It shows a yield on Yahoo of 11.5% at the current price. Nothing bad will happen until it does. Or put differently, risk happens fast and if the whole Strategy story crumbles, STRC might drop like a Wylie Coyote cartoon. Isolating that risk isn't too difficult, knowing when it will happen is pretty much impossible. Once you really break a risk down to simple terms, you can then make an informed decision about whether it is a risk you should take. I am surprised how steady it has been.

Larry Swedroe wrote about risk, diversification and risk adjusted returns. He hinted at this but if you have a diversified portfolio, you are going to have a few things that will "make you want to puke" as Jason Buck said. Once an investor realizes it's not in their interest to try to optimize for one week but for long periods of time, it becomes easier to endure a period where something is simply lagging or to endure when a diversifier that is intended to offset equity volatility does just that. You don't want your diversifiers to be your best performers. 

This was interesting;

We've looked at this a little bit with the Unlimited Long/Short Equity ETF (HFEQ) which targets not twice the return of long short but twice the volatility. At some point I may have mentioned the Unlimited Managed Futures ETF (HFMF) which targets twice the volatility of regular managed futures. 

I think this sort of idea for now anyway is a better way to add capital efficiency than the far more common twice the return levered funds that reset every day. But using something like client personal holding BTAL to leverage down, as we've described it previously, into slightly more equity exposure also works. 

To point number 1 about the allocator needing to do the rebalancing, I'm not sure why that it a problem. It's a task to be done but I don't think it's a problem. For point number 2, I think there is an embedded assumption that variance drain (volatility drag) can be modeled or predicted but it's path dependent. 

Anytime we've ever done some sort of long term study with the 2X S&P 500 ETF (SSO) it tracks 2x the index pretty closely most of the time. It delivers the general effect most of the time. Levered funds tracking narrower things or more volatile indexes tend to deviate more. SSO may not be close enough for you and just because it is pretty close most of the time, the wrong sequence will cause a lot of pain.

In 21 full and partial years since SSO started trading, I would say that 2020, 2018, 2015, 2011 and 2007 are when the deviation might have been uncomfortable certainly but not catastrophic. The way to use it, if there is any way in this context would not be to put 30% into SSO and think you've got 60% equities. More like, 50% into plain vanilla equities and maybe 5% in SSO to get to 60 exposure leaving 5% left over for some sort of diversifier or maybe 45 and 7.5 leaving 7.5 left over for a diversifier. 

Does it work when doubling the volatility in managed futures like HFMF?

The sample size is limited but based on first impressions, not really. Looking at long/short equity, there are more successful months than with managed futures.

But then this gets interesting.

The 2x volatility works in this comparison.

The period is too short to draw a conclusion about the performance but the volatility numbers are close and although you can't see it, the standard deviation numbers are even closer to each other. 

The concept is valid and yes there would be work to do but unless you're putting it all in one target date funds (not bagging on that), then any portfolio strategy you implement will require work. 

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 Citrini Gloomsday Portfolio

The other day I said I'd try to put something together that might work if Citrini Research's prediction possible outcome stemming from AI plays out. As a reminder here's what they spelled out for two years from now.

• Unemployment rate hits 10%
• 30% decline in the S&P 500
• Home prices fall at least 10% in some big markets including NYC, LA and Chicago
• Labor income drops below 50% of GDP
• CPI goes negative

I came up with this;

Instead if QLEIX which is leveraged up here, I plan to monitor this idea using 15% in HFEQ which is long biased L/S that targets 2x volatility. I used JEPI but I would swap out that equity beta for BTYB that we looked at on Sunday. Since that fund is only a month old, it makes no sense to back test it yet. NFLY is a crazy high yielder yes but it avoids crazy CEO risk like a couple of the crazy high yielders have and I think would be an important piece of this puzzle but without completely selling out the portfolio for yield.

The managed futures is split as you can see but doesn't have a big weighting. We know it can take a bit for managed futures to adjust during regime changes. 

I wouldn't focus on the returns looking back. It is designed to be less volatile than 60/40 which it is, with smaller drawdowns which has also been the case. Much smaller drawdowns. It gets a lot of yield from just three sources/25% of the portfolio but there would be a little interest rate risk using BTYB, less though than with VBAIX in case rates go up. Yes, in a deflationary environment, the book says yields go down but I don't want to bet on too much normalcy from the treasury market. If yields do go down then 10% in BTYB should get some benefit.  

One thing I did not model in was asymmetry. I'm not sure Bitcoin is the answer in this context. I'm still holding as I outlined recently but if you want to model in a small slice to asymmetry I would look elsewhere like maybe uranium or something that might benefit from the AI gloomsday that Citrini is talking about. 

Infrastructure as a theme might makes sense. Client personal holding CBOE might benefit if VIX trading and a few other things see outsized trading volume growth.

Going 100% cash is probably a bad way to go. It's suboptimal at a minimum in case Citrini turns out to be completely wrong about this or it kind of plays out the way they suggest but with a much smaller impact on the equity market. Even if they're exactly right, after stocks bottom out, they will start to go up and eventually make a new high. Guessing on when the bottom is in has a low probability of success. The first draft of this portfolio we created for this post has holdings that have the opportunity to go up, even be antifragile, in the face of Citrini's AI Gloomsday scenario. 

BTAL, ARBIX, MERIX and NOC are in my ownership universe.

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.

This Derivative Income ETF Might Not Be Horrible

Quick hit Sunday.

A few weeks ago we mentioned the Vistashares Bitbonds 5 Year Weekly Income Fund (BTYB) which had just started trading. The fund is 80% long five year treasuries and 20% in a Bitcoin synthetic covered call with the objective of generating twice the yield versus just owning a five year treasury.

Obviously it's been a rough run for Bitcoin since BTYB listed but the result is far from horrible. The chart is price only, so adding back in the 15 cents it has paid out so far and the drag from Bitcoin has been less than 100 basis points compared to the UFIV ETF. YBTC is a crazy high yielding covered call fund tracking Bitcoin. It's only a month but I like the idea of harnessing volatility to add a little bit of yield. Maybe BTYB can actually achieve that. There is still interest rate risk though even with just five years. In 2022, IEI which tracks 3-7 year treasuries bottomed out with just over a 12% decline at it's still $12 below its late 2021 high.

From Torsten Slok. No immigration is economically serious. 

Here's a link to the Citrini Research piece that really upset markets a couple of weeks ago. Here's the TLDR from Bloomberg.

• US unemployment rate exceeds 10% 

• S&P 500 declines more than 30% from its level at time of launch

• Zillow Home Value Index declines more than 10% YoY in any of: NYC, LA, San Francisco, Chicago, Houston, Phoenix 

• Labor share of gross domestic income first-release value for any quarter falls below 50% 

• CPI falls below 0% in any monthly release 

Citrini leads off saying this is not a prediction, it's merely one possible outcome over the next couple of years. Bloomberg added that Kalsi currently shows a 13% probability of three of the five happening by July of 2028. 

When I see any sort of gloomsday (play on words of doomsday) predictions possible outcomes, my inclination is to think about resiliency of not just the portfolio but also my various income streams. Portfolio resiliency could come from small exposures to inverse strategies, managed futures (after the first 10% down), a mix of different long/short including absolute return, gold can work in a deflationary environment and there will be some others including defense contractors based on the current geopolitical environment. A crazy thought is that funds like BTYB could work too. Higher yield, not crazy high yield. 

Later this week I will try to put together an anti-Citrini Portfolio, could be fun.

Resiliency of income streams involves learning new things, making sure current income streams can adapt if needed and not being over reliant on any single income stream. I'd also encourage working on trying to add an additional income stream. I think a related point is to start to build into your planning the idea that Congress will not actually be able figure out the Social Security problem. As crazy as it sounds, they might actually screw this up. 

I bet you saw the headline from the WSJ about The Crossing Guard Making $14,000 A Month Mailing Out Her Musings From The Job. The article says she took the crossing guard job to better "connect with her community" for 50 minutes a day without implying she gave up her day job. Then her day job sort of withered shortly thereafter though. It reads like the opportunity found her but she took on the crossing guard gig expecting nothing, then had an idea and was able to monetize it very successfully. It's a great example of what we've been talking about here for a long time. 

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.

When Does A Crappy Deal Become Good?

First this.

We've made this point before. There is an element of private equity/credit firms needing retail bag holders' via 401k plans to soak up deal supply. I do not think 401k plans have any shot of getting in on the "good deals." 

How did Robinhood's private markets retail fund do on day one?

The $4 dollar drop isn't as bad as it first seems. The first print was at $22, a $3 drop. That is likely the sales charge paid by people who bought on the offering. Never buy closed end funds on the offering. There is a process where the sales charge gets worked quickly off in the market. If the sales charge was $3 then people buying the offering were paying $25 for $22 worth of assets. It doesn't look like the sales charge is publicly available but some or all of the $3 drop is the market discounting whatever the actual sales charge was and doing it very quickly. 

A funny story that I've told before. I worked at Morgan Stanley for about ten minutes in 2002/2003 and there was some sort of closed end fund offering and of course there was a sales credit available to us for any shares we placed. Knowing how these work, I stayed away. I got asked about it by a senior guy in the office, I explained the sales charge issue, he got pissed and told me I was wrong. Of course that is exactly what happened but he never brought it up again. From back then, I remember the sales charge being more like a buck and half but maybe it was more for RVI due to it being riskier....or crappier. 

Boaz Weinstein from Saba is partnering with Cox Capital to try to buy a lot of Blue Owl's distressed assets. Blue Owl was able to sell some of the good stuff for more than 99 cents on the dollar to meet some redemption demand. It looks like Saba and Cox are trying to buy assets from Blue Owl between 65 cents and 80 cents on the dollar. 

I saw a comment somewhere about this noting that if Weinstein is trying to buy, retail investors should not be so quick to sell. There is logic to that of course. I am glad I don't have to try to make that decision but there is a price where what was originally a crappy deal becomes a good deal. Buying RVI at a big premium wasn't a good idea but buying at some whopper of a discount might be.

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 About The First 10% Down?

Today I moved clients to be a touch more defensive by buying a little of an inverse fund. The risk of this event going from stocks being down a little to being down a lot has increased based on the private credit deterioration that appears to be under way and the disruption in the oil market being caused by the war in Iran which could cause economic problems here. The US doesn't get oil from the middle east anymore so supply won't be disrupted here but price has already been disrupted. Additionally, this morning's job report showed a job loss of about 90,000 people which was far below consensus yet price inflation is still running a little hot.

We should hope that the trade today proves out to have been unnecessary and that the market rips higher from here but this is insurance in case it does go down a lot. If stocks drop, the inverse exposure will grow to protect more of the portfolio (convexity) and if stocks go right back up, the inverse exposure will shrink to be less of a drag (negative convexity).

The above passage is most of what I communicated internally to the advisors who outsource portfolio management to me. To my clients reading this, you'll get an email tonight covering a lot of the same ground.

For a little more color, the point isn't to try to predict anything. Risks have increased so I am reducing the portfolio's equity beta without selling. Twenty years ago, there were far fewer ways to buy protection. The way that product sophistication has evolved, I think it is better to buy protection than sell beta. What if today was the bottom? If so, the stocks exposure I didn't sell has the opportunity to go up with the market while the slice I added today would shrink in relation to the rest of the portfolio. 

Slight pivot, Simplify has a short paper up in support of its new capital efficient ETF CTAP which is 100% equities and 100% managed futures similar to RSST. The argument for using CTAP is similar to what the ReturnStacked guys say to support their funds. The big idea is that you can maintain a 60/40 portfolio and then add managed futures exposure to help reduce tracking error.

The idea of reducing tracking error doesn't really click with me in the context they mean it. We've talked about this before. Clients don't seem to care about fixed income performance unless bonds are tanking. I had a new thought that I might have some sort of bias here. Long time readers might recall that I've pretty much never had any exposure to duration, very very little. I didn't word it this way back then but the compensation for duration hasn't been adequate in ages. I have some understanding of the distress caused by bonds tanking from when I started subadvising for the other advisors I mentioned. Absolute carnage. 

This was an easy thing to observe. How is 3% adequate for ten years let along two years let alone 58 basis points? If you were reading my stuff back then you read this from me in real time. The new thought is that since I've never relied on duration in any kind of meaningful way, clients had a small position in TOTL for a while, I don't miss it in constructing portfolios, I don't need to find a way to make room for AGG-like exposure. 

Here's a podcast from RCM that goes into great detail about managed futures in this context and related topics. One point made very plainly is that we should not expect much from managed futures during the first 10% down. Think about last April, managed futures got pummeled. It was a crash that ended quickly. A managed futures program would need to be heavily weighted to hourly signals to have had a shot at doing well during that bad week. 

Thursday of this past week, pretty much everything went down except inverse and oil. Gold down. Managed futures down. Defense contractors down. Even CBOE which is often a proxy for VIX when the market drops was down. Oh, and bonds were down. 

At this point, if you're a frequent reader you already know whether you agree with me or disagree with me about duration now being useless as a reliable diversifier but if you agree that duration has become less reliable then leveraging up to own equities, duration and managed futures has a high chance of doing much worse during the first 10% down than some sort unlevered combo of those three.

This is last April. Is it much worse? That might be in the eye of the beholder but the leverage in Portfolio 1 is certainly noticeably worse. Part of the pitch for the new generation of capital efficient strategies is that they are not levering up one asset, equities on top of equities. They are levering up with what should be uncorrelated assets. Uncorrelated except for the first 10% down.

I place great importance on figuring out what to avoid (or underweight). If you can do that every so often then you are inviting tracking error and I don't think that's a bad thing. Quite the opposite. 

It makes sense to continue to study capital efficiency, it's fascinating and the space is evolving which hopefully means better products or better ways to build it yourself. The concept we've gravitated for now is leveraging down where including strategies that have a reliably negative correlation to equities or no correlation can allow for slightly nudging up exposure to equities (the thing that goes up the most, most of the time). Another application of the concept is what we've been talking about this week with the two long short funds that sort of lever up but in different ways. HFEQ targets 2x volatility. A 20% weight to that fund would be 40% of your equity exposure in terms of volatility (maybe returns, it depends) leaving 20% to collect some low volatility yield so something similarly boring (boring is good in this context).

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 First Major Test For Private Credit"

Making my usual rounds on Thursday, I stumbled into this item.

Yikes! Here the two Cliffwater funds I've heard of.

Here's me in May, 2005;

Here's more from the New York Times posted on Tuesday. The title for this post came from the NYT article. The Times really hit on the idea of a potential "mismatch between assets and liabilities" as more people would want to get out than there would be money coming in. The interval fund concept works in part because money comes in at some rate that might generally balance out redemption requests. The risk is that the money in/money out dynamic is at immediate risk of unraveling. Someone was quoted saying "no one wants to be the last one out."

To my excerpt, is something going horribly wrong? Obviously there is no way to know. We've repeatedly looked at companies like Blackstone (BX) and the rest as being proxies for whatever is going on in the private asset space. The stocks are collectively down a ton from their highs. They appear to be capturing something going on with private assets and these various anecdotes from Blue Owl and any others out there could very well be the canary in the coalmine as alleged by David Rosen in the above Tweet. 

Navigating various types of adverse market events, I guess this one is a credit event, is difficult enough, putting yourself into a position of not being able to sell due to structural reasons would seem to make matters far worse. 

As we have seen in previous events, it's not realistic to count on completely avoid the thing, exposure to credit in this instance, but it can be realistic to effectively limit the amount of exposure. Clients own Blackrock whose alternative division swims in these waters so the stock is feeling it some but that division isn't very big, it's not insignificant but retail products are far larger. I have a bank loan fund and short term high yield fund in my ownership universe and they are pretty much flat on the year for now. 

If you know my style of portfolio construction, you know the allocations are very small, like 8-10% of the fixed income sleeve when the client has a "normal" allocation to equities. So 10% of 40%. I certainly would never want to explain to a client why some fund that was 4-5% of their account imploded but that would be nowhere near as bad as to trying explain why 1/4 of their account vaporized.

Repeated for emphasis from hundreds of previous posts, keep allocations small and don't load up on the same type of risk. Putting your 40% fixed income allocation into ten different funds that are all vulnerable to the same risk is not diversification. 

I doubt this event is in the first inning but it's probably not in the 8th or 9th inning 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.

Not Nest Egg, Paycheck For Life

Andrew DeBeer who manages the iMGP DBi Managed Futures Strategy ETF (DBMF) as well as having involvement with the Simplify DBi CTA Managed Futures Index ETF (SDMF) sat for Barry Ritholtz' podcast. There wasn't a lot that was new but one item that I would pass along from it was Andrew's suggestion of allocating about 3% to managed futures. Barry led into that by saying it's not something you backup the truck on. 

Yesterday we looked at long biased long/short funds. WTLS is 90/90, 90% S&P 500 and then 90% long biased long/short. HFEQ seeks twice the volatility of regular long biased long/short. Yesterday, both funds were down more than the broad market and today they were both up more than the broad market even if not by that much in the case of WTLS.

At this point, I am not saying they are good funds or not, just that based on a first impression, both days the funds were behaving the way I think they should behave. Plenty of funds don't pass this test and maybe with a longer sample size these wouldn't either but when I talk about a fund doing what they say it will do, this is how to see, very simple but it is very important point. A fund is offering something, does it actually do it?

Don't think of your 401k and then when it becomes your Rollover IRA as a nest egg, think of it as "paycheck for life." That is part of the pitch from Blackrock to provide access to private assets for retirement plans. While I am a no on private assets due to lack of liquidity, high fees and volatility laundering, the idea of annuitizing a portion of assets intrigues me. Not annuities. Annuitizing with brokerage account accessible products that have daily liquidity. 

We've played around with this idea in various ways a few times. The way I framed it, a window of like five years where someone wants to retire but not take Social Security right away. Maybe this person has a piece of money in a taxable account, separate from their 401k/IRA that they are willing to deplete over something like four or five years to let their retirement account and Social Security benefit grow.

I sat in on a webinar from NorthernTrust today. They have a suite of funds that sort of do this, annuitize an income stream from funds that deplete in 2030 TIPA/MUNA, 2035 TIPB/MUNB, 2045 TIPC/MUNC and 2055 TIPD/MUND respectively. The symbol starting with T buys TIPS and the symbols starting with M buys muni bonds. 

We looked at these briefly when they first listed. Given the intended use, I'm not sure why the suite goes beyond 2035. If you can retire right now at 47, are you going to buy TIPC or MUNC so you can delay SS until age 66? It doesn't make sense to me. 

The webinar included a use case of someone 62 today wanting to retire now and use the 2030 product to hold out taking SS until 67. Here's what TIPA owns.

Every October, a tranche matures and get distributed. During the year, the fund pays a "dividend" periodically. I thought they said monthly but that must have been incorrect. Here's what Yahoo shows for distributions.

I spent a lot of time looking to see if there were more distributions and couldn't find any evidence of more and neither could Grok. The fund's webpage doesn't have any info about the distribution history. 

The idea is to collect income and principal back to live off of for a finite period expecting to deplete the piece of money just as you start to collect Social Security. The example from the webinar assumed that the guy had $200,000 to commit to the income bridge strategy. I like that name better than depletion strategy I came up with. 

The price of the fund is around $100/share for now. The dividends seem lumpy as hell. Next fall, the use case investor would get about $40,000 shortly after the first tranche matures. Let's say the yield from actual dividends is 3% (very little confidence it would be that high) spread sporadically over the year, that would be $6000 and then in the fall you get $40,000. It would take a lot of planning to make that work. You'd essentially need your first year's worth of expenses set aside and not include in the $200,000 purchase of TIPA. 

This idea will evolve into more useable funds. There are a couple of others out there, LifeX has a couple of funds that do something similar. If fund companies are creating these, there must be some sort of demand but like a lot of strategies, the first couple of attempts might not be the final solution. 

For now, I think with a little research work, people can build this themselves. Sticking with the $200,000 example, I bet we could find 10-15 disparate strategies with varying degrees of kind of high to crazy high yields that take disparate risks. Then set a schedule of taking paychecks that are a mix of accrued distributions and principal. With a five to seven year time horizon would this strategy last longer than just spending it out of a money market yielding 3.5%?

You'd really want to spread the risk around but we've looked at this before, yes this strategy can last a little longer than just straight cash out of a money market. Putting 6 or 7% in a crazy higher yielder or two is less crazy when the expectation is that the account will deplete. 

I spent two minutes coming up with 12 holdings. Maybe someone actually applying themselves would come up with something better. (hint, take my list, put into whatever AI you use and ask it to make improvements)

The "yield" annualized out to 12.29% so call it $24,000, take another $16,000 out by selling down positions and one year in, $183,000 with four years left until Social Security. If someone wanted wait ten years, then they'd only take out $20,000 which was less that the "yield" for year one. 

For the period studied, just owning VBAIX and selling it would have been better. It's an interesting theory that I think could work but may not always be optimal. 

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.