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.